Conditions for Survival: Changing Risk and the Performance of Hedge Fund Managers and Ctas

29 Pages Posted: 11 Nov 2008  

Stephen J. Brown

New York University - Stern School of Business

William N. Goetzmann

Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)

James M. Park

PARADIGM Capital Management

Multiple version iconThere are 2 versions of this paper

Date Written: June 1999

Abstract

Investors in hedge funds and commodity trading advisors [CTA] are naturally concerned with risk as well as return. In this paper, we investigate whether hedge fund and CTA return variance depends upon whether the manager is doing well or poorly. Our results are consistent with the Brown, Harlow and Starks (1996) findings for mutual fund managers. We find that good performers in the first half of the year reduce the volatility of their portfolios, and poor performers increase volatility. These variance strategies" depend upon the fund s ranking relative to other funds. Interestingly enough, despite theoretical predictions, changes in risk are not conditional upon distance from the high water mark threshold, i.e. a ratcheting absolute manager benchmark. This result may be explained by the relative importance of fund termination. We analyze factors contributing to fund disappearance. Survival depends on both absolute and relative performance. Excess volatility can also lead to termination. Finally, other things equal, the younger a fund, the more likely it is to fail. Therefore our results strongly confirm an hypothesis of Fung and Hsieh (1997b) that reputation costs have a mitigating effect on the gambling incentives implied by the manager contract. Particularly for young funds, a volatility strategy that increases the value of a performance fee option may lead to the premature death of that option through termination of the fund. The finding that hedge fund and CTA volatility is conditional upon past performance has implications for investors, lenders and regulators.

Suggested Citation

Brown, Stephen J. and Goetzmann, William N. and Park, James M., Conditions for Survival: Changing Risk and the Performance of Hedge Fund Managers and Ctas (June 1999). NYU Working Paper No. FIN-99-077. Available at SSRN: https://ssrn.com/abstract=1299447

Stephen J. Brown

New York University - Stern School of Business ( email )

Stern School of Business
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New York, NY 10012-1126
United States
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212-995-4233 (Fax)

William N. Goetzmann

Yale School of Management - International Center for Finance ( email )

165 Whitney Ave.
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-5950 (Phone)
203-436-9252 (Fax)

HOME PAGE: http://viking.som.yale.edu

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

James M. Park

PARADIGM Capital Management ( email )

12 East 49th Street, 32nd floor
New York, NY 10017
United States
212-271-3388 (Phone)
212-271-3393 (Fax)

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