This paper explores the investment styles in mutual funds and hedge funds. The results indicate t... more This paper explores the investment styles in mutual funds and hedge funds. The results indicate that there are 39 dominant mutual fund styles that are mixes or specialized subsets of nine broadly defined asset classes. There is little evidence of market timing or asset class rotation in these dominant mutual fund styles. There are five dominant hedge fund styles. Two are correlated with broadly defined asset classes, while the other three are dynamic trading strategies on a number of asset classes. Thus, a 12-factor model with nine asset classes and three dynamic trading strategies should provide a good first step in a unified approach for performance attribution and style analysis of mutual funds and hedge funds.
The dramatic increase in the number of hedge funds and the "institutionalization" of th... more The dramatic increase in the number of hedge funds and the "institutionalization" of the industry over the past decade have spurred rigorous research into hedge fund performance. This research has tended to uncover more questions than answers about the dynamic and multifaceted hedge fund industry. ; This article presents a simple hedge fund business model in which fund returns are a function of three key elements -- how the funds trade, where they trade, and how the positions are financed. The article also provides methods to help investors, intermediaries, and regulators identify systemic risk factors inherent in hedge fund strategies. ; Estimating these risk factors requires having an accurate history of hedge fund performance. The authors examine recent statistics from three commercial hedge fund databases and discuss the problems with database biases that must be recognized to obtain accurate measures of returns. ; While the data show that today's hedge funds use m...
We acknowledge the LBS Centre for Hedge Fund Research and Education for providing the hedge fund ... more We acknowledge the LBS Centre for Hedge Fund Research and Education for providing the hedge fund data used in this paper. Earlier versions of this paper were presented at Abstract This paper studies the risk in fixed-income hedge fund styles. Principal component analysis is applied to groups of fixed-income hedge funds to extract common sources of risk and return. These common sources of risk are related to market risk factors, such as changes in interest rate spreads and options on interest rate spreads. We call these asset-based style factors (" ABS "). The paper finds that fixed-income hedge funds tend to be exposed to a common ABS factor: credit spreads. Hedge fund strategies came under intense scrutiny in the wake of the stressful market events surrounding the collapse of Long-Term Capital Management (LTCM). Several studies have been sponsored by regulatory agencies of financial markets: the President's Working Group on Financial Markets [1999], and Bank for Inter...
Over the past decade, academic research has identified a number of replication strategies capable... more Over the past decade, academic research has identified a number of replication strategies capable of capturing between 40% to 80% of the average return of many popular hedge fund strategies. Investors are beginning to take notice of these replication strategies, especially because of their rule based, transparent features and the fact that they can be executed at low cost. Armed with this alternative way of accessing passive hedge fund returns, investors can effectively structure incentive fee contracts to reward skill-based returns (i.e., alternative alpha) differently from passive index-liked returns (i.e., alternative beta). This can raise the barrier to entry for new funds to the industry in that hedge fund managers must demonstrate skill in order to participate in profi t sharing. This should reduce the risk of herding by hedge fund managers who may otherwise be enticed by incentive fee contracts that rewards them for taking popular factor bets.
Performance track records contain valuable information, as long as investors correct for the bias... more Performance track records contain valuable information, as long as investors correct for the biases inherent in using surviving funds. This paper analyzes the effect of survivorship in private funds managed by commodity trading advisors (CTAs). It finds that the dissolution rate and dissolution cost in CTA funds are higher than in mutual funds. Style analysis is not affected by survivorship. CTA funds have a dominant style, identified to be a trend following strategy. A CTA style factor with minimal survivorship bias can be constructed, proxying for the systematic risk in CTA funds. The dissolution cost to investors is further reduced by reputation effects. Multi-fund management companies behave differently than single-fund management companies when it comes to terminating unsuccessful funds in order to protect their reputation.
The Chicago Board Options Exchange generously supplied option listing data used in this study. Th... more The Chicago Board Options Exchange generously supplied option listing data used in this study. The suggestions of Giorgio Szegö and two anonymous referees have greatly improved the paper. Thanks also to seminar participants at Duke University and the 1995 FMA annual meeting. In addition, David Hsieh, Chris Kirby, Tom Smith, and Robert E. Whaley provided many helpful comments.
Theory suggests that long/short equity hedge funds’ returns come from directional as well as spre... more Theory suggests that long/short equity hedge funds’ returns come from directional as well as spread bets on the stock market. Empirical analysis finds persistent net exposures to the spread between small versus large cap stocks in addition to the overall market. Together, these factors account for more than 80 percent of return variation. Additional factors are price momentum and market activity. Combining two major branches of hedge fund research, our model is the first that explicitly incorporates the effect of funding (stock loan) on alpha. Using a comprehensive data set compiled from three major database sources, we find that among the three thousand plus hedge funds with similar style classification, less than twenty percent of long/short equity hedge funds delivered significant, persistent, stable positive non-factor related returns. Consistent with the predictions of the Berk and Green (2004) model we find alpha producing funds decays to “beta-only” over time. However, we do ...
Abstract This paper shows that the mean-variance analysis of hedge funds approximately preserves ... more Abstract This paper shows that the mean-variance analysis of hedge funds approximately preserves the ranking of preferences in standard utility functions. This extends the results of Levy and Markowitz (1979)[Levy, H., Markowitz, HM, 1979. Approximating expected utility ...
This paper tests the hypothesis that traders have rational expectations and charge no risk premiu... more This paper tests the hypothesis that traders have rational expectations and charge no risk premium in the forward exchange market. It uses a statistical procedure which is consistent under a large class of heteroscedasticity, and a set of data which takes into account the institutional features of the forward exchange market. The results show that inferences using this procedure are very different from those using the standard assumption of homoscedastici ty.
... Hours worked per week Imports and exports Output of manufacturing Real GDP Nominal GDPWage ra... more ... Hours worked per week Imports and exports Output of manufacturing Real GDP Nominal GDPWage rates in ... 360 DA Hsieh, Determination of the real exchange rate Besides using a very arbitrary and highly aggregated ... Furthermore, this may be affected by cyclical variations. ...
The term market microstructure was coined in 1976 by Mark Garman to define "moment-to-moment trad... more The term market microstructure was coined in 1976 by Mark Garman to define "moment-to-moment trading activities in asset markets." With the stated goal of providing insight and testable implications regarding the transaction-totransaction nature of realistic exchange processes, Garman examines dealership and auction models of marketmakers where the stream of market orders from a collection of market agents is depicted as a stochastic Poisson process. The resulting insights concern bid-ask spreads (based on standard microeconomic analysis), inventories of marketmakers, and the effects of some market power on the part of marketmakers. A more recent microstructure literature is based on information asymmetries among economic agents. In a recent literature review, Admati (1991) defines the area of market microstructure as "the literature on asset markets with asymmetric information and especially on trading mechanisms" (p. 347); Garman is noted as an example of "earlier market microstructure literature" in which "information issues were not typically modelled" (p. 355, n. 11). Two reasons are given for the popularity of asymmetric information models: policy implications of different trading processes, as exemplified by the 1987 crash, and empirical results such as various patterns in trading volume, variances, and returns over the trading day. The belief is that better insights into both issues will be achieved by examining information asymmetries. Moreover, observed empiri
This paper explores the investment styles in mutual funds and hedge funds. The results indicate t... more This paper explores the investment styles in mutual funds and hedge funds. The results indicate that there are 39 dominant mutual fund styles that are mixes or specialized subsets of nine broadly defined asset classes. There is little evidence of market timing or asset class rotation in these dominant mutual fund styles. There are five dominant hedge fund styles. Two are correlated with broadly defined asset classes, while the other three are dynamic trading strategies on a number of asset classes. Thus, a 12-factor model with nine asset classes and three dynamic trading strategies should provide a good first step in a unified approach for performance attribution and style analysis of mutual funds and hedge funds.
The dramatic increase in the number of hedge funds and the "institutionalization" of th... more The dramatic increase in the number of hedge funds and the "institutionalization" of the industry over the past decade have spurred rigorous research into hedge fund performance. This research has tended to uncover more questions than answers about the dynamic and multifaceted hedge fund industry. ; This article presents a simple hedge fund business model in which fund returns are a function of three key elements -- how the funds trade, where they trade, and how the positions are financed. The article also provides methods to help investors, intermediaries, and regulators identify systemic risk factors inherent in hedge fund strategies. ; Estimating these risk factors requires having an accurate history of hedge fund performance. The authors examine recent statistics from three commercial hedge fund databases and discuss the problems with database biases that must be recognized to obtain accurate measures of returns. ; While the data show that today's hedge funds use m...
We acknowledge the LBS Centre for Hedge Fund Research and Education for providing the hedge fund ... more We acknowledge the LBS Centre for Hedge Fund Research and Education for providing the hedge fund data used in this paper. Earlier versions of this paper were presented at Abstract This paper studies the risk in fixed-income hedge fund styles. Principal component analysis is applied to groups of fixed-income hedge funds to extract common sources of risk and return. These common sources of risk are related to market risk factors, such as changes in interest rate spreads and options on interest rate spreads. We call these asset-based style factors (" ABS "). The paper finds that fixed-income hedge funds tend to be exposed to a common ABS factor: credit spreads. Hedge fund strategies came under intense scrutiny in the wake of the stressful market events surrounding the collapse of Long-Term Capital Management (LTCM). Several studies have been sponsored by regulatory agencies of financial markets: the President's Working Group on Financial Markets [1999], and Bank for Inter...
Over the past decade, academic research has identified a number of replication strategies capable... more Over the past decade, academic research has identified a number of replication strategies capable of capturing between 40% to 80% of the average return of many popular hedge fund strategies. Investors are beginning to take notice of these replication strategies, especially because of their rule based, transparent features and the fact that they can be executed at low cost. Armed with this alternative way of accessing passive hedge fund returns, investors can effectively structure incentive fee contracts to reward skill-based returns (i.e., alternative alpha) differently from passive index-liked returns (i.e., alternative beta). This can raise the barrier to entry for new funds to the industry in that hedge fund managers must demonstrate skill in order to participate in profi t sharing. This should reduce the risk of herding by hedge fund managers who may otherwise be enticed by incentive fee contracts that rewards them for taking popular factor bets.
Performance track records contain valuable information, as long as investors correct for the bias... more Performance track records contain valuable information, as long as investors correct for the biases inherent in using surviving funds. This paper analyzes the effect of survivorship in private funds managed by commodity trading advisors (CTAs). It finds that the dissolution rate and dissolution cost in CTA funds are higher than in mutual funds. Style analysis is not affected by survivorship. CTA funds have a dominant style, identified to be a trend following strategy. A CTA style factor with minimal survivorship bias can be constructed, proxying for the systematic risk in CTA funds. The dissolution cost to investors is further reduced by reputation effects. Multi-fund management companies behave differently than single-fund management companies when it comes to terminating unsuccessful funds in order to protect their reputation.
The Chicago Board Options Exchange generously supplied option listing data used in this study. Th... more The Chicago Board Options Exchange generously supplied option listing data used in this study. The suggestions of Giorgio Szegö and two anonymous referees have greatly improved the paper. Thanks also to seminar participants at Duke University and the 1995 FMA annual meeting. In addition, David Hsieh, Chris Kirby, Tom Smith, and Robert E. Whaley provided many helpful comments.
Theory suggests that long/short equity hedge funds’ returns come from directional as well as spre... more Theory suggests that long/short equity hedge funds’ returns come from directional as well as spread bets on the stock market. Empirical analysis finds persistent net exposures to the spread between small versus large cap stocks in addition to the overall market. Together, these factors account for more than 80 percent of return variation. Additional factors are price momentum and market activity. Combining two major branches of hedge fund research, our model is the first that explicitly incorporates the effect of funding (stock loan) on alpha. Using a comprehensive data set compiled from three major database sources, we find that among the three thousand plus hedge funds with similar style classification, less than twenty percent of long/short equity hedge funds delivered significant, persistent, stable positive non-factor related returns. Consistent with the predictions of the Berk and Green (2004) model we find alpha producing funds decays to “beta-only” over time. However, we do ...
Abstract This paper shows that the mean-variance analysis of hedge funds approximately preserves ... more Abstract This paper shows that the mean-variance analysis of hedge funds approximately preserves the ranking of preferences in standard utility functions. This extends the results of Levy and Markowitz (1979)[Levy, H., Markowitz, HM, 1979. Approximating expected utility ...
This paper tests the hypothesis that traders have rational expectations and charge no risk premiu... more This paper tests the hypothesis that traders have rational expectations and charge no risk premium in the forward exchange market. It uses a statistical procedure which is consistent under a large class of heteroscedasticity, and a set of data which takes into account the institutional features of the forward exchange market. The results show that inferences using this procedure are very different from those using the standard assumption of homoscedastici ty.
... Hours worked per week Imports and exports Output of manufacturing Real GDP Nominal GDPWage ra... more ... Hours worked per week Imports and exports Output of manufacturing Real GDP Nominal GDPWage rates in ... 360 DA Hsieh, Determination of the real exchange rate Besides using a very arbitrary and highly aggregated ... Furthermore, this may be affected by cyclical variations. ...
The term market microstructure was coined in 1976 by Mark Garman to define "moment-to-moment trad... more The term market microstructure was coined in 1976 by Mark Garman to define "moment-to-moment trading activities in asset markets." With the stated goal of providing insight and testable implications regarding the transaction-totransaction nature of realistic exchange processes, Garman examines dealership and auction models of marketmakers where the stream of market orders from a collection of market agents is depicted as a stochastic Poisson process. The resulting insights concern bid-ask spreads (based on standard microeconomic analysis), inventories of marketmakers, and the effects of some market power on the part of marketmakers. A more recent microstructure literature is based on information asymmetries among economic agents. In a recent literature review, Admati (1991) defines the area of market microstructure as "the literature on asset markets with asymmetric information and especially on trading mechanisms" (p. 347); Garman is noted as an example of "earlier market microstructure literature" in which "information issues were not typically modelled" (p. 355, n. 11). Two reasons are given for the popularity of asymmetric information models: policy implications of different trading processes, as exemplified by the 1987 crash, and empirical results such as various patterns in trading volume, variances, and returns over the trading day. The belief is that better insights into both issues will be achieved by examining information asymmetries. Moreover, observed empiri
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Papers by David A Hsieh