On The Persistence Of Selectivity And Market Timing Skills In Hedge Funds

Abstract

This paper investigates the persistence of hedge fund managers skills during periods of boom and/or recession. We consider a data set of monthly investment strategy indices published by Hedge Fund Research group. The data set spans from January 1995 to June 2010. We divide this sample period into four overlapping sub-sample periods that contain different economic cycles. We define a skilled manager as a manager who can outperform the market consistently during two consecutive sub-sample periods. We first estimate outperformance, selectivity and market timing skills using both linear and quadratic Capital Asset Pricing Model-CAPM. Persistence in performance is carried out in three different fashions: contingence table, chi-square test and cross-sectional auto-regression technique. The results show that fund managers have the skills to outperform the market during periods of positive economic growth only. This market outperformance is due to both selectivity and market timing skills. These results contradict the Efficient Market Hypothesis-EMH due to limited arbitrage opportunity.

Do mutual funds remain persistent? Evidence from Pakistan

“…They conclude that winners repeat their performance during periods of negative market returns while losers maintain their performance during good market returns. Mwamba (2013) examine the persistence of hedge fund managers' skills for boom and recession periods. They use 6500 hedge Fund managers across the world.…”

“…Cortez et al (1999) conclude that approaches like rank portfolio or regression (past performance on future performance) are not suitable for small markets due to limited data availability constraint. For two-period persistence test, this study constructs contingency tables for winners and losers (Mwamba, 2013). This test scrutinizes the frequency with which winners and loser funds remain in the same category in both time-periods.…”

“…To proceed, the mutual funds are categorized as winners (W) or losers (L). A manager is defined as a winner (looser) if the performance measure (intercept term as result of his investment strategies) is higher (lower) than the median of all the performance measures in that category (Mwamba, 2013).…”

“…If investors find predictability in funds' performance, may transfer their investments towards winner funds to reap abnormal returns (Cuthbertson, Nitzsche, & OŚullivan, 2008). There are numerous studies that examine persistence in performance of mutual funds (Brown, Goetzmann, Ibbotson, & Ross, 1992;Vicente & Ferruz, 2005;Babalos, Caporale, Kostakis, & Philippas, 2008;Mwamba, 2013;Goetzmann & Ibbotson, 1994), and come up with mixed results. Studies by Wermers (2003); Cremers and Petajisto (2009) ;Huij and Post (2011) find evidence of persistence.…”

“…Emerging markets, like Pakistan are professed to be less efficient than developed markets and so one might perceive that they provide more opportunities to fund managers to get abnormal returns as compared to developed markets. Mwamba (2013) argue that the market itself contains some irrational agents that lead to inefficiency of markets and investors have heterogeneous expectations for risk and returns. This causes the fund managers to adjust their portfolios to opt for various investment strategies and trying to outclass the market.…”