FRM-Hedge Funds Performance Risk and Capital Forma

1、HedgeFunds:Performance,RiskandCapitalFormation*WilliamFungLondonBusinessSchoolDavidA.HsiehDukeUniversityNarayanY.NaikLondonBusinessSchoolTarunRamadoraiUniversityofOxfordandCEPRThisversion:March10,2006AbstractWeuseacomprehensivedatasetofFunds-of-Hedge-Funds(FoFs)toinvestigateperformance,riskandcapitalformationinthehedgefundindustryoverthepasttenyears.WeconfirmthefindingofhighsystematicriskexposuresinFoFreturns.Wedivideupthepasttenyearsintothreedistinctsub-periodsanddemonstratethattheaverageFoFha。

2、sonlydeliveredalphaintheshortsecondperiodfromOctober1998toMarch2000.Inthecross-sectionofFoFs,however,weareabletoidentifyFoFscapableofdeliveringpersistentalpha.WefindthatthesemoresuccessfulFoFsexperiencefargreater(andsteadier)capitalinflowsthantheirlessfortunatecounterparts.BerkandGreen’s(2004)rationalmodelofactiveportfoliomanagementimpliesthatdiminishingreturnstoscalecombinedwiththeinflowofnewcapitalleadstotheerosionofsuperiorperformanceovertime.Inkeepingwiththisimplication,weprovideevidencethat。

3、evensuccessfulFoFshaveexperiencedarecent,dramaticdeclineinrisk-adjustedperformance.JELClassifications:G11,G12,G23Keywords:hedgefunds,funds-of-hedge-funds,performance,alpha,factormodels,flow*WethankOmerSulemanandespeciallyAasmundHeenforexcellentresearchassistance.WethankJohnCampbell,HarryMarkowitz,LudovicPhalippouandseminarparticipantsattheLondonSchoolofEconomics,UniversityofOxford,StockholmInstituteforFinancialResearch,WarwickUniversity,theIXIS-NYUhedgefundconferenceandU.MassAmherstforcomments.W。

4、egratefullyacknowledgesupportfromtheBSIGammaFoundationandfromtheBNPParibasHedgeFundCentreattheLondonBusinessSchool.WilliamFung:bfung@london.edu;DavidHsieh:dah7@mail.duke.edu;NarayanNaik:nnaik@london.edu;TarunRamadorai:tarun.ramadorai@sbs.ox.ac.uk1Hedgefundsareconsideredbysometobetheepitomeofactivemanagement.Theyarelightlyregulatedinvestmentvehicleswithgreattradingflexibility,andtheyoftenpursuehighlysophisticatedinvestmentstrategies.Hedgefundspromise‘absolutereturns’totheirinvestors,leadingtoabel。

5、iefthattheyholdfactor-neutralportfolios.Theyhavegrowninsizenoticeablyoverthepastdecadeandhavebeenreceivingincreasingportfolioallocationsfrominstitutionalinvestors.1Accordingtopressreports,anumberofhedgefundmanagershavebeenenjoyingcompensationthatiswellinexcessofU.S.$10millionperannum.Howmuchofthehypeistrue?Weareawarefromavarietyofpastresearchpapersthattherearerisksinherentinhedgefundreturns.2However,inthecourseofactiveportfoliomanagement,riskexposuresareboundtochangewithmarketconditions.Canwecap。

6、turethetimevariationintheserisks?Canwecharacterizeinterestingdifferencesinrisk-adjustedperformanceoralphainthecross-sectionofhedgefunds?Canweusethesedifferencestopredictthefutureperformanceofcertainhedgefunds?Howhavecapitalflowsrespondedtocross-sectionalandtime-seriesmovementsinrisk-adjustedhedgefundperformance?Doestheentryofsophisticatedinvestorsheraldareductionintheperformanceofhedgefunds?Inthispaper,weinvestigatetheseimportantquestions.Indoingso,weprovideabodyofevidencethatstronglysupportsBer。

7、kandGreen’s(2004)modelofactiveportfoliomanagement.BerkandGreen’smodelhasthreekeyfeatures.First:investorscompetitivelyprovidecapitaltofunds.Second,managershavedifferentialabilitytogeneratehighreturns,butfacedecreasingreturnstoscaleindeployingtheirability.Third,investorslearnaboutmanagerialabilityfrompastperformanceanddirectmorecapitaltowardsfundswithsuperiorperformance.Thesefeatures,wedemonstrate,areevidentinthehedgefundindustry,providinguswithaninterestinglaboratorytotestthepredictionsoftheirrat。

8、ionalmodelofactivemanagement.1AccordingtotheTASSAssetFlowsreport,aggregatehedgefundassetsundermanagementhavegrownfromU.S.$72billionattheendof1994toover$670billionattheendof2004.2SeeAgarwalandNaik(2005)foracomprehensivesurveyofthehedgefundliterature.2TherearetwomainimplicationsoftheBerkandGreenmodel.Weprovideevidencethattheseimplicationsareindeedtrueinthecaseofhedgefunds.First,weshowthatmoresuccessfulfundsexperiencefargreatercapitalinflowsthantheirlessfortunatecounterparts.Asecondimplicationofthe。

9、irmodelisthatdiminishingreturnstoscalecombinedwiththeinflowofnewcapitalleadstoerosionofsuperiorperformanceovertime.Inkeepingwiththisimplication,weprovideevidencethatevensuccessfulfundshaveexperiencedarecent,dramaticdeclineinrisk-adjustedperformance.Beforeonecanusethedataonhedgefundsorhedgefundindexestoexaminetheseissues,onehastominimizethebiasesinthesedata.Thesebiasesarisefromalackofuniformreportingstandardsgiventhelackofregulation.Forexample,hedgefundmanagerscanelectwhethertoreportperformanceat。

10、all,andiftheydo,theycandecidethedatabase(s)towhichtheyreport.Theycanalsoelecttostopreportingattheirdiscretion.3Thisbiasesthereturnsreportedbyhedgefundindexesupwards.Furthermore,real-lifeconstraintsmakethehedgefundindexreturnsdifficulttoreplicate.Forexample,somehedgefundsincludedintheindexmaybeclosedtonewmoney,ormayevenbereturningmoney.Inaddition,hedgefundsoftenimposeconstraintsonthewithdrawalofmoney,usinglockupperiods,noticeandredemptionperiods.Moreimportantly,thehedgefundindexreturnsdonotreflect。