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Abstract:
Using a new database of hedge funds, this paper provides a comprehensive analysis of the risk-return characteristics, risk exposures, style analysis and performance persistence of various hedge fund strategies. We conduct a mean-variance analysis to find that a combination of alternative investments and passive indexing provides significantly better risk-return tradeoff than passively investing in the different asset classes. Using a broad asset class factor model, we find that the hedge fund strategies outperform the benchmark by a range of 6% to 15% per year. We infer the significant risk exposures of different hedge fund strategies using generalized style analysis and find results consistent with their investment objectives. Finally, using parametric and non-parametric methods, we examine persistence in the performance of hedge fund managers. We find a reasonable degree of persistence which seems to be attributable more to the losers continuing to be losers instead of winners continuing to be winners.

Abstract:
Since hedge fund returns exhibit non-linear option-like exposures to standard asset classes (Fung and Hsieh (1997a, 2000a)), traditional linear factor models offer limited help in evaluating the performance of hedge funds. We propose a general asset class factor model comprising of excess returns on passive option-based strategies and on buy-and-hold strategies to benchmark the performance of hedge funds. Our model is a generalized version of Glosten and Jagannathan (1994) and it explicitly accounts for non-linear nature of payoffs displayed by hedge funds. Although in practice hedge funds can follow a myriad of dynamic trading strategies, we find that a few simple option writing/buying strategies are able to explain a significant proportion of variation in the hedge fund returns over time. In general, we find that hedge fund strategies added significant value (in excess of estimated survivorship bias) in the early nineties but less so in the late nineties. We also find that aggregated across all funds in our sample, hedge funds that do not use leverage show, on average, larger alphas and better information ratios compared to the funds that use leverage, across different time periods.

Abstract:
Since hedge funds specify significant lockup periods, we investigate persistence in the performance of hedge funds using a multi-period framework in which the likelihood of observing persistence by chance is lower than that in the traditional two-period framework. Under the null hypothesis of no manager skill (no persistence), the theoretical distribution of observing wins or losses follows a binomial distribution. We test this hypothesis using the traditional two-period framework and compare the findings with the results obtained using our multi-period framework. We examine whether persistence is sensitive to the length of return measurement intervals by using quarterly, half-yearly and yearly returns. We find maximum persistence at quarterly horizon indicating that persistence among hedge fund managers is short-term in nature. It decreases as one moves to yearly returns and this finding is not sensitive to whether returns are calculated on a pre- or post-fee basis suggesting that the intra-year persistence finding is not driven by the way performance fees are imputed. The level of persistence in the multi-period framework is considerably smaller than that in the two-period framework with virtually no evidence of persistence using yearly returns under the multi-period framework. Finally persistence, whenever present, seems to be unrelated to whether the fund took directional bets or not.

Hedge funds, performance, persistence

Abstract:
Since hedge funds specify significant lockup periods, we investigate persistence in the performance of hedge funds using a multi-period framework in which the likelihood of observing persistence by chance is lower than that in the traditional two-period framework. Under the null hypothesis of no manager skill (no persistence), the theoretical distribution of observing wins or losses follows a binomial distribution. We test this hypothesis using the traditional two-period framework and compare the findings with the results obtained using our multi-period framework. We examine whether persistence is sensitive to the length of return measurement intervals by using quarterly, half-yearly and yearly returns. We find maximum persistence at quarterly horizon indicating that persistence among hedge fund managers is short-term in nature. It decreases as one moves to yearly returns and this finding is not sensitive to whether returns are calculated on a pre- or post-fee basis suggesting that the intra-year persistence finding is not driven by the way performance fees are imputed. The level of persistence in the multi-period framework is considerably smaller than that in the two-period framework with virtually no evidence of persistence using yearly returns under the multi-period framework. Finally persistence, whenever present, seems to be unrelated to whether the fund took directional bets or not.

Abstract:
This paper investigates the determinants of money-flows, nature of managerial incentives, behavior of investors, and drivers of performance in the hedge fund industry. It examines performance-flow relation and finds that funds with good recent performance, greater managerial incentives, and lower impediments to capital withdrawals experience higher money-flows. It also analyzes how current money-flows relate to future performance and finds that larger funds with greater inflows are associated with poorer future performance, a result consistent with decreasing returns to scale. It also finds that funds with greater managerial incentives are associated with superior future performance, justifying investors' preference for funds with higher managerial incentives.

Abstract:
In this paper, we shed light on the key drivers of the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds and delta hedging the equity risk can explain the dynamics of their returns. In addition, we demonstrate the effects of extreme market-wide events and supply of convertible bonds on hedge fund performance. We conduct out-of-sample tests using new data and find corroborative evidence. Our findings are consistent with convertible arbitrageurs collectively playing the role of intermediaries that provide funding to convertible bond issuers whilst transferring the equity risk of convertible bond ownership to the equity market through hedging.

Hedge Funds, Convertible Bonds, Convertible Arbitrage, Supply

Abstract:
Using a comprehensive hedge fund database, we examine the role of managerial incentives and discretion in hedge fund performance. Hedge funds with greater managerial incentives, proxied by the delta of the option-like incentive fee contracts, higher levels of managerial ownership, and the inclusion of high-water mark provisions in the incentive contracts, are associated with superior performance. The incentive fee percentage rate by itself does not explain performance. We also find that funds with a higher degree of managerial discretion, proxied by longer lockup, notice, and redemption periods, deliver superior performance. These results are robust to using alternative performance measures and controlling for different data-related biases.

Hedge Funds, Managerial Incentives, Discretion, Performance, Delta, Lockup Period

Abstract:
Recently there has been a rapid growth in the assets managed by "hedged mutual funds" - mutual funds mimicking hedge funds strategies. In this paper, we examine the performance of these funds relative to hedge funds and traditional mutual funds. We find that despite their use of similar trading strategies, hedged mutual funds underperform hedge funds. We attribute this evidence to lighter regulation and better incentives faced by hedge funds. In contrast, hedged mutual funds outperform traditional mutual funds. Most interesting, this superior performance is largely driven by managers with experience in implementing hedge fund strategies. Our findings have important implication for investors seeking hedge-fund-like payoffs at a lower cost and within the comfort of a regulated environment.

Hedge funds, mutual funds, hedged mutual funds, hybrid mutual funds

Abstract:
Recently, there has been explosive growth in two products from the hedge fund industry - multi-strategy (MS) funds and funds of hedge funds (FOFs), both of which offer diversification across different hedge fund strategies. In well-functioning markets, both investment vehicles should offer similar returns. Over the period 1994 - 2004, we find that MS funds outperform FOFs on a risk-adjusted basis by 2.6% to 4.8% per year on gross-of-fee and by 3.0% to 3.6% per year on net-of-fee basis. The superior performance of MS funds continues to hold even when we control for fund characteristics such as size, management and incentive fees, and other conventional control variables. Since FOFs underperform MS funds on both net- and gross-of-fee basis, their underperformance cannot be entirely explained by their double-layered fee structure. The question then is how MS funds and FOFs can co-exist in equilibrium in view of the significant differential in performance? We suggest that investors perceive greater agency risk in the structure of MS funds relative to FOFs and therefore require greater compensation for investing in MS funds. MS funds are able to generate these higher returns because they possess greater investment flexibility and are able to invest in less liquid assets. It is also possible that MS funds generate greater returns because managers with "better" ability self-select into joining MS funds and the competition among MS funds results in the rents from superior ability being passed on to the investors in the form of better returns. Controlling for the differences in agency risk, flexibility, and fee structure between MS funds and FOFs, our results suggest that self-selection by managers with superior ability in MS funds may be the driving force behind their superior performance relative to FOFs.

Multistrategy hedge funds, Funds of hedge funds, Performance, Fees, Agency risk, Investment flexibility

Abstract:
Since it is well known that hedge fund returns exhibit non-linear option-like exposures to standard asset classes, traditional linear factor models offer limited help in capturing the risk-return tradeoffs offered by hedge funds. This paper employs a combination of passive buy-and-hold strategies and option-based strategies to characterize the risks of different hedge fund strategies. Although, in practice, these hedge funds can follow a myriad of dynamic trading strategies, we find that adding a few simple option writing/buying strategies to the linear multi-factor model enables us to capture a significant proportion of the variation in the hedge fund returns over time. We verify the ability of our approach to capture important hedge fund risk exposures by conducting out-of-sample analysis. Our approach can provide valuable insights into the nature of risks involved in investing in different hedge fund strategies.

Abstract:
This paper is the first to document that hedge fund returns during December are significantly higher than those during the rest of the year. This December spike cannot be fully explained by increase in the funds' risk exposures or by higher factor risk premiums in December. It contends that the contractual features provide hedge funds incentives to inflate returns at year-end and provides strong evidence in support of this argument. It also shows that the spike is higher for funds with greater opportunities to inflate returns. Finally, it demonstrates that funds inflate December returns by under-reporting returns earlier in the year and/or by borrowing from January returns in the following year.

Hedge Funds, Incentives, Returns Management

Abstract:
This paper examines higher-moment market risks in the cross-section of hedge fund returns to make several contributions. First, it is shown that hedge funds, but not mutual funds, are substantially exposed to volatility, skewness, and kurtosis risks. We find significant cross-sectional variation in the intensity of higher-moment exposures across hedge fund styles and across hedge funds within a particular style, suggesting potential for neutralizing higher-moment risks. Corroborating this result, when funds of hedge funds are investigated as a separate investment category they do not show aggressive loading on higher-moment risks. Second, we provide evidence on economically significant premiums being embedded in hedge fund returns on account of their exposures to higher-moment risks. Third, we uncover a set of higher-moment factors that are not strongly associated with factors in benchmark models that are currently used for evaluating hedge fund performance. Finally, the addition of higher-moment factors to benchmark models can better explain the behavior of hedge fund returns. Bearing on issues of practical consequence, benchmark models augmented with higher-moment factors can considerably alter the hedge funds' alpha-based rankings.

volatility risk, skewness risk, kurtosis risk, higher moments, exposures, hedge funds, alphas

Abstract:
This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases.

Confidential holdings; disclosure; 13F

Abstract:
This paper characterizes the systematic risk exposures of hedge funds using buy-and-hold and option-based strategies. Our results show that a large number of equity-oriented hedge fund
strategies exhibit payoffs resembling a short position in a put option on the market index, and therefore bear significant left-tail risk, risk that is ignored by the commonly used mean-variance framework. Using a mean-conditional Value-at-Risk framework, we demonstrate the extent to which the mean-variance framework underestimates the tail risk. Finally, working with the systematic risk exposures of hedge funds, we show that their recent performance appears significantly better than their long-run performance.

hedge funds, option-based trading strategies, conditional Value-at-Risk, tail risk and multifactor models