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Luck or skill: What drives hedge fund performance persistence?
Written By: Ekaterina Ipatova, Mamata Parhi, Tapas Mishra, Kaizad Doctor Abstract This paper produces multiple fund-of-funds’ portfolios based on sorting and a novel nonparametric approach to lend in-depth insights into the extent hedge fund returns display higher order (non-linear) persistence patterns. By exploiting monthly data from Hedge Fund Research Database between 1999:1 to 2015:12, an out-of sample exercise provides robust evidence of performance persistence over the time horizon. However, up to 80% of hedge funds appear to be ‘lucky’ performers, confirmed upon undertaking a battery of robustness measures. We name those ‘lucky’ hedge funds, which pass the classical persistence selection procedure and are selected ‘by accident’ with regard to funds with persistent returns. We argue that these funds are unlikely to experience significant outperformance in the future. Our non-parametric identification mechanism allows for a reduced number of persistent funds, enabling practitioners to focus on a few with meaningful qualitative scrutiny. Moreover, we expand the debate in the literature by analysing post-crisis data and demonstrating that after the 2008 crisis, the proportion of genuinely persistent funds got significantly reduced.…
Incorporating Alternative Risk Premia into Balanced Portfolios: Is there any added value?
Written by: Francesc Naya, Jahja Rrustemi, Nils S. Tuchschmid Abstract Evaluating the performance of Alternative Risk Premia products as standalone investments is not sufficient to conclude whether these products add value to institutional investors, whose portfolios are largely composed of well-diversified equity and bond allocations, and usually smaller ones to alternatives assets, including alternative risk premia products. In this article, we study whether the inclusion of ARP products add value to two well-known benchmarks of balanced allocations: the 60/40 world equity/bond portfolio and the Pictet LPP 2015-60 index. Taking a sample period from 2016 to May 2021 of live ARP products, we find that a systematic allocation to ARP with no equity exposure significantly improves risk-adjusted performance measures, due to risk reduction, even though it caused a small drag in compounded return over the long term. This impact is somehow similar to the one many investors seek in Trend-Following funds or Tail-Hedge products, for which we compare results. Finally, the drag in performance disappears if one can dynamically manage the inclusion of ARP into the balanced portfolios, even though it is well-known that market timing ability is at the very least a rare asset.…
Advisory Firm Paths to Side-By-Side Management and Mutual Fund Performance
Written by: Jongwan Bae, Timothy Haight, Chengdong Yin Abstract We examine the performance of mutual funds under side-by-side (SBS) management with hedge funds from a new perspective. Using SEC filings to identify advisory firms engaged in SBS management, we find that mutual fund performance is affected by an advisory firm’s path to SBS management (i.e., whether they started with mutual funds or hedge funds). While no significant path effects are observed when SBS advisers started with mutual funds, we observe significant outperformance when SBS advisers started with hedge funds. However, the performance benefit provided by SBS advisers that started with hedge funds becomes insignificant when SBS management is conducted at the portfolio manager level. Further analysis suggests that these effects relate to the relative contributions of mutual funds and hedge funds to advisers’ total assets and compensation. SBS advisers that started with mutual funds rely heavily on mutual funds for both assets and compensation, which could explain why mutual fund performance does not suffer when these advisers expand into hedge funds. Meanwhile, SBS advisers that started with hedge funds derive more of their assets from mutual funds, though hedge funds generally contribute more to their total compensation. These patterns suggest there are adviser-level incentives to deliver strong mutual fund performance (which attracts capital from new investors) and manager-level incentives to favor hedge funds (which increases compensation).…
Hedge Fund Performance: A Quantitative Survey
Written by: Fan Yang, Tomas Havranek, Zuzana Irsova, Jiri Novak Abstract We provide the first quantitative survey of the empirical literature on hedge fund performance. We examine the impact of potential biases on the reported results. Empirical analysis in prior studies has been plagued by fragmentation of underlying data and by limited consensus on how hedge fund performance should be measured. Using a sample of 1,019 intercept terms from regressions of hedge fund returns on risk factors (the “alphas”) collected from 74 studies published between 2001 and 2021 we show that inferences about hedge fund returns are not significantly contaminated by publication selection bias. Most of our monthly alpha estimates adjusted for the (small) bias fall within a relatively narrow range of 30 to 40 basis points. Considering several partitions of our sample, we document a modest publication bias only for estimates based on instrumental variables (IV), for which relatively large standard errors are common and that tend to be less precise. In contrast, studies that explicitly control for the potential biases in the underlying data (e.g. the backfilling bias and the survivorship bias) report lower alphas. Our results demonstrate that despite the prevalence of the publication selection bias in numerous other research settings, publication may not be selective when there is no strong a priori theoretical prediction about the sign of estimated coefficients, which may induce greater readiness to publish statistically insignificant results.…
Decentralized Finance, Crypto Funds, and Value Creation in Tokenized Firms
Written by: Douglas Cumming, Niclas Dombrowski, Wolfgang Drobetz, Paul P. Momtaz Abstract Crypto Funds (CFs) represent a novel investor type in entrepreneurial finance. CFs intermediate Decentralized Finance (DeFi) markets by pooling contributions from crowd-investors and investing in tokenized startups, combining sophisticated venture- and hedge-style investment strategies. We compile a unique dataset combining token-based crowdfunding (or Initial Coin Offerings, ICOs) data with proprietary performance data of CFs. CF-backed startup ventures obtain higher ICO valuations, outperform their peers in the long run, and benefit from token price appreciation around CF investment disclosure in the secondary market. Moreover, CFs beat the market by roughly 2.5% per month. Their outperformance is persistent, suggesting that CFs deliver abnormal returns because of skill, rather than luck. These performance effects for CFs and CF backed startups are driven by a fund’s investor network centrality. Overall, our study paves the way for research on what some refer to as the “crypto fund revolution” in entrepreneurial finance.…
Hedge Fund Investment in ETFs
Written by: Douglas Cumming, Pedro Monteiro Abstract This paper examines the causes and consequences of hedge fund investments in exchange traded funds (ETFs) using U.S. data from 1998 to 2018. The data indicate that transient hedge funds and quasi-indexer hedge funds are substantially more likely to invest in ETFs. Unexpected hedge fund inflows [outflows] cause a rise [reduction] in ETF investments, and the economic significance of unexpected flow is more than twice as large for transient than quasi-indexer hedge funds. Expected hedge fund flows are statistically unrelated to ETF investments on average. When ETF investment is accompanied by an increase in unexpected flow, hedge fund alphas are higher. When ETF investment is accompanied by an increase in expected flow, hedge fund alphas are lower. The data are consistent with the view that hedge fund ETF investment unrelated to unexpected flow is an agency cost of delegated portfolio management.…
The All-Weather Portfolio Approach: The Holy Grail of Portfolio Management
Written by: Youssef Louraoui Abstract This research article aims to analyze the All-Weather strategy advocated by the very famous hedge fund manager Ray Dalio. Through an analysis of nearly 10 year of market data, we have selected ETF funds to replicate the investment principle by using a classic approach. We present the different results that suggest an overall performance that converge with the original analysis proposed in the Bridgewater Associates (2009) research paper that shows the benefits of the All Weather approach on the overall portfolio risk/return trade-off.…
Which Investors Drive Factor Returns?
Written by: Morad Elsaify Abstract Different investors hold different portfolios. To explain this phenomenon, I build a model in which investors have different information processing capabilities. The model predicts that highly capable investors specialize in factor timing, hold more volatile and dispersed portfolios, and reduce average risk premia and volatility. Using novel empirical measures of investors’ capabilities and information choices, I find that hedge funds are the most capable investors, while insurance companies and pension funds are the least. Variation in factor timing ability is the primary driver of these differences. Investors’ portfolios exhibit properties consistent with the model’s predictions. Using a demand system approach, I show that hedge funds have the greatest per-dollar impact on expected returns, shrinking expected returns in the factor zoo by nearly 40% per $1 trillion of invested capital.…
Anti-Herding by Hedge Funds, Idiosyncratic Volatility and Expected Returns
Written by: Sara Ali, Ihsan Badshah, Riza Demirer Abstract Utilizing a dataset of 1,899 U.S. hedge funds, we present evidence of anti-herding behaviour among hedge fund managers in the U.S. Hedge funds anti-herd primarily based on fundamental information and irrespective of market volatility and credit deterioration conditions although funding illiquidity has a stronger effect on the formation of anti-herding behaviour across the majority of hedge fund schemes analysed. Interestingly, however, we observe a greater deal of heterogeneity across the different hedge fund categories, particularly during crisis periods, with certain hedge fund schemes including Convertible Arbitrage, Equity Market Neutral and Fixed Income Arbitrage experiencing herding driven by the COVID-19 induced market uncertainty. More importantly, we document significant economic implications of anti-herding and show that hedge funds associated with high degree of anti-herding earn significantly higher excess returns over those with low degree of anti-herding, particularly in the intermediate and long horizons up to one year. At the same time, hedge funds that anti-herd experience greater idiosyncratic volatility in subsequent periods, presenting a novel perspective to the relationship between anti-herding, idiosyncratic volatility and expected returns. While the finding of antiherding in the hedge fund industry is not unexpected as the main attraction of hedge funds is to devise proprietary trading strategies that is based on private information, our findings provide novel insight to the link between idiosyncratic volatility and expected returns in the context of anti-herding in the hedge fund industry.…
Alpha Capture Systems: Past, Present, and Future Directions
Written by Francois-Serge Lhabitant and Denis Mirlesse for EDHEC Business School…
Diverse Hedge Funds
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