Careers and Survival: Competition and Risk in the Hedge Fund and Cta Industry

31 Pages Posted: 13 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: October 2000

Abstract

Investors in hedge funds and commodity trading advisors [CTA s] are naturally concerned with risk as well as return. In this paper, we investigate risk of hedge funds and CTA s in light of managerial career concerns. We find an association between past performance and risk levels consistent with Brown, Harlow and Starks (1996) findings for mutual fund managers. 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. The importance of relative rankings as opposed to the absolute ranking suggested by analysis of hedge fund and CTA manager contracts points to the importance of reputation costs. These costs are best thought of in the context of the career concerns of managers and 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 disappear from the sample. 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. An important result of our finding is that variance strategy depends upon relative rather than absolute performance evaluation.

Suggested Citation

Brown, Stephen J. and Goetzmann, William N. and Park, James M., Careers and Survival: Competition and Risk in the Hedge Fund and Cta Industry (October 2000). NYU Working Paper No. S-AM-00-06. Available at SSRN: https://ssrn.com/abstract=1300794

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)

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Cambridge, MA 02138
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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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