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The authors investigate the leverage of hedge funds in the time series and cross section. They find that hedge fund leverage is counter-cyclical to the leverage of listed financial intermediaries and decreases prior to the start of the financial crisis in mid-2007. Hedge fund leverage is lowest in early 2009 when the market leverage of investment banks is highest. Changes in hedge fund leverage tend to be more predictable by economy-wide factors than by fund-specific characteristics. In particular, decreases in funding costs and increases in market values both forecast increases in hedge fund leverage. Decreases in fund return volatilities predict future increases in leverage.
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Thursday, March 17, 2011
Skill, Luck and the Multiproduct Firm: Evidence from Hedge Funds
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Is it more important for hedge fund managers to be lucky or skilled when expanding to offer new products?
How about both?
In "Skill, Luck and the Multiproduct Firm: Evidence from Hedge Funds," Wharton management professor Evan Rawley and Rui J.P. de Figueiredo, Jr., of the University of California Berkeley, explore how strong returns from existing hedge funds drive launches of new products. They observe that, while many funds post strong returns at some point in time, the "lucky" funds separate themselves from the "skilled" funds based on their diversification choices immediately afterwards.
The fee structure of hedge funds drives them to launch new funds; more expansive is always better when working off a percentage of gross returns without "clawbacks." But fund managers understand that launching new funds can reveal their weaknesses as money managers. So while the authors show that most managers wait until they generate strong returns to launch a new fund, investors have good reason not to worry that a fund contacting them for money is basing the pitch on a single fluke period. The poor manager knows he or she cannot sustain those strong returns, and that opening a new fund presents a tremendous risk to his or her reputation, Rawley notes. Meanwhile, the skilled manager knows that he or she can benefit from diversification into a new fund and keep that reputation intact.
To demonstrate this effect, Rawley and de Figueiredo followed a select sample of 1,353 funds from 1994 to 2006. While 676 of these funds remained "focused," the remainder launched a new fund. The study finds that the new funds boasted returns of six basis points higher per month per unit of risk compared to focused funds; the higher returns suggest superior fund management.
But that does not necessarily mean that only the weaker funds chose to stay focused. "There are some good firms that want to remain focused, and there are some bad, lucky firms that end up diversifying," Rawley says, meaning that a lack of diversification might not be sufficient grounds to reject investing in a hedge fund. Specific factors, like the existing fund's clients and the cost of launching a new fund, may prevent "skilled" funds from branching out.
In addition, there are some limitations to applying this theory outside of the hedge fund industry, according to Rawley. Hedge fund managers usually have their own wealth in the fund, making them averse to the short-term versus long-term tradeoffs that industrial managers might make. Hedge funds must also go to capital markets to fund expansions, while companies in the "real economy" might fund expansions with money from their own balance sheets. But Rawley suggests that the study may help other researchers or industry analysts to better understand the role of luck and skill in other business contexts. "We show that both of these effects are important. You can't just talk about one in isolation."
Is it more important for hedge fund managers to be lucky or skilled when expanding to offer new products?
How about both?
In "Skill, Luck and the Multiproduct Firm: Evidence from Hedge Funds," Wharton management professor Evan Rawley and Rui J.P. de Figueiredo, Jr., of the University of California Berkeley, explore how strong returns from existing hedge funds drive launches of new products. They observe that, while many funds post strong returns at some point in time, the "lucky" funds separate themselves from the "skilled" funds based on their diversification choices immediately afterwards.
The fee structure of hedge funds drives them to launch new funds; more expansive is always better when working off a percentage of gross returns without "clawbacks." But fund managers understand that launching new funds can reveal their weaknesses as money managers. So while the authors show that most managers wait until they generate strong returns to launch a new fund, investors have good reason not to worry that a fund contacting them for money is basing the pitch on a single fluke period. The poor manager knows he or she cannot sustain those strong returns, and that opening a new fund presents a tremendous risk to his or her reputation, Rawley notes. Meanwhile, the skilled manager knows that he or she can benefit from diversification into a new fund and keep that reputation intact.
To demonstrate this effect, Rawley and de Figueiredo followed a select sample of 1,353 funds from 1994 to 2006. While 676 of these funds remained "focused," the remainder launched a new fund. The study finds that the new funds boasted returns of six basis points higher per month per unit of risk compared to focused funds; the higher returns suggest superior fund management.
But that does not necessarily mean that only the weaker funds chose to stay focused. "There are some good firms that want to remain focused, and there are some bad, lucky firms that end up diversifying," Rawley says, meaning that a lack of diversification might not be sufficient grounds to reject investing in a hedge fund. Specific factors, like the existing fund's clients and the cost of launching a new fund, may prevent "skilled" funds from branching out.
In addition, there are some limitations to applying this theory outside of the hedge fund industry, according to Rawley. Hedge fund managers usually have their own wealth in the fund, making them averse to the short-term versus long-term tradeoffs that industrial managers might make. Hedge funds must also go to capital markets to fund expansions, while companies in the "real economy" might fund expansions with money from their own balance sheets. But Rawley suggests that the study may help other researchers or industry analysts to better understand the role of luck and skill in other business contexts. "We show that both of these effects are important. You can't just talk about one in isolation."
Saturday, March 12, 2011
Barclay Hedge Fund Index Gains 1.18% in February
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Hedge Funds Are Up Six Months in a Row
Hedge funds gained 1.18% in February according to the Barclay Hedge Fund Index compiled by BarclayHedge. The Index is up 1.65% year-to-date.
“In the face of Mideast political turmoil and rising commodity prices, the rally in developed market equity prices extended to a sixth consecutive month,” says Sol Waksman, founder and president of BarclayHedge.
“Hedge funds have been able to take advantage of the favorable trading environment as evidenced by a gain of 11.1 percent in the Barclay Hedge Fund Index over the past six months.”
Overall, 16 of Barclay’s 18 hedge fund indices had positive returns in February. The Barclay Equity Long Bias Index gained 3.05%, Technology was up 2.31%, Convertible Arbitrage gained 1.65%, Multi Strategy added 1.55%, and Fixed Income Arbitrage rose 1.42%.
“Treasury markets were mixed as fears of inflation early in the month were supplanted by geopolitical uncertainties as the month progressed,” says Waksman.
“Prices for high yield debt continued to increase as demand from yield-hungry investors remained strong.”
The Equity Short Bias Index lost 2.91% in February, and the Emerging Markets Index slid 0.58%. Equity Short Bias is now down 3.61% in 2011 after two months of trading.
The Barclay Fund of Funds Index gained 0.86% in February.
Click here to view five years of Barclay Hedge Fund Index data, or download 13 years of monthly data.
BarclayHedge was founded in 1985 and actively tracks more than 6,000 hedge funds, funds of hedge funds, and managed futures programs. Each month Barclay provides updated performance rankings for 38 Hedge Fund categories and 16 CTA categories.
Hedge Funds Are Up Six Months in a Row
Hedge funds gained 1.18% in February according to the Barclay Hedge Fund Index compiled by BarclayHedge. The Index is up 1.65% year-to-date.
“In the face of Mideast political turmoil and rising commodity prices, the rally in developed market equity prices extended to a sixth consecutive month,” says Sol Waksman, founder and president of BarclayHedge.
“Hedge funds have been able to take advantage of the favorable trading environment as evidenced by a gain of 11.1 percent in the Barclay Hedge Fund Index over the past six months.”
Overall, 16 of Barclay’s 18 hedge fund indices had positive returns in February. The Barclay Equity Long Bias Index gained 3.05%, Technology was up 2.31%, Convertible Arbitrage gained 1.65%, Multi Strategy added 1.55%, and Fixed Income Arbitrage rose 1.42%.
“Treasury markets were mixed as fears of inflation early in the month were supplanted by geopolitical uncertainties as the month progressed,” says Waksman.
“Prices for high yield debt continued to increase as demand from yield-hungry investors remained strong.”
The Equity Short Bias Index lost 2.91% in February, and the Emerging Markets Index slid 0.58%. Equity Short Bias is now down 3.61% in 2011 after two months of trading.
The Barclay Fund of Funds Index gained 0.86% in February.
Click here to view five years of Barclay Hedge Fund Index data, or download 13 years of monthly data.
BarclayHedge was founded in 1985 and actively tracks more than 6,000 hedge funds, funds of hedge funds, and managed futures programs. Each month Barclay provides updated performance rankings for 38 Hedge Fund categories and 16 CTA categories.
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