Investor behavior: hedge fund returns and strategies

2017 ◽  
Vol 9 (1) ◽  
pp. 14-42 ◽  
Author(s):  
Andres Bello ◽  
Jan Smolarski ◽  
Gökçe Soydemir ◽  
Linda Acevedo
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Management Style ◽  
Active Management ◽  
Warning Sign ◽  
Content Type ◽  
Market Sentiment ◽  
Irrational Behavior ◽  
Market Fundamentals ◽  
Hedge Fund Returns

Purpose The purpose of this paper is to investigate to what extent hedge funds are subject to irrationality in their investment decisions. The authors advance the hypothesis that irrational behavior affects hedge fund returns despite their sophistication and active management style. Design/methodology/approach The irrational component may follow a pattern consistent with the observed hedge fund returns yet far distant from market fundamentals. The authors include factors beyond the original version of capital asset pricing model such as Fama and French and Carhart models, as well as less stringent models, such as APT and Fung and Hsieh, to test whether these models are able to capture the irrational nature of the residuals. Findings After finding that institutional irrational sentiments play a role in hedge fund returns, we note that the returns are not completely shielded against irrational trading; however, hedge fund returns appear to be affected only by the irrational component derived from institutional trading rather than that emanated from individuals. Research limitations/implications Different sources of irrationality may have asymmetric effects on hedge fund returns. Using a different set of sophisticated investors along with different market sentiment proxies may yield different results. Practical implications The authors argue that investors can use irrational beta to gauge the extent of institutional irrational sentiments prevailing in markets for the purpose of re-adjusting their portfolios and therefore use the betas as an early warning sign. It can also guide investors in avoiding funds and strategies that display greater irrational behavior. Originality/value The study advance the idea that the unexpected, hereafter irrational, component may follow a pattern consistent with the observed hedge fund returns, yet different from market fundamentals.

Are hedge fund returns affected by media coverage of macroeconomic news?

2019 ◽  
Vol 36 (3) ◽  
pp. 427-439
Author(s):  
Sandip Dutta ◽  
James Thorson
Keyword(s):  
Hedge Funds ◽  
Media Coverage ◽  
Hedge Fund ◽  
Real Sector ◽  
Macroeconomic News ◽  
Content Type ◽  
Fund Managers ◽  
News Announcements ◽  
Hedge Fund Returns ◽  
The Impact

Purpose Extant literature suggests that the difficulty associated with the interpretation of macroeconomic news announcements by the market in general in different economic environments, might be the reason why most studies do not find any significant relationship between real-sector macroeconomic variables and financial asset returns. This paper aims to use a different approach to measure macroeconomic news. The objective is to examine if a different measure of a macroeconomic news variable, constructed from media coverage of the same, significantly affects hedge fund returns. Design/methodology/approach The authors use a news index for unemployment, which is a real-sector variable, constructed from newspaper coverage of unemployment announcements and examine its impact on hedge fund returns. Findings Contrary to the other studies that examine the impact of macroeconomic news on hedge fund returns, the authors find that media coverage of unemployment news announcements significantly affects hedge fund returns. Practical implications Overall, this paper demonstrates that the manner in which the market interprets macroeconomic news announcements in different economic environments is probably a more relevant factor for hedge funds and is more likely to impact hedge fund returns. In conjunction with variables – constructed from media coverage of unemployment news announcements – that factor in the manner of interpretation, it is found that surprises also matter for hedge fund returns. This is an important consideration for hedge fund managers as well. Originality/value To the best of the authors’ knowledge, this is the first study that examines the impact of media coverage of macroeconomic news announcements on hedge fund returns and finds significantly different results with real-sector macro variables.

Flagging potential fraudulent investment activity

2016 ◽  
Vol 23 (4) ◽  
pp. 882-901
Author(s):  
Jeremy King ◽  
Gary Wayne van Vuuren
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Sharpe Ratio ◽  
Financial Fraud ◽  
Investment Activity ◽  
Content Type ◽  
Limited Success ◽  
Bias Ratio ◽  
Return Distributions ◽  
Hedge Fund Returns

Purpose This paper aims to investigate the use of the bias ratio as a possible early indicator of financial fraud – specifically in the reporting of hedge fund returns. In the wake of the 2008-2009 financial crisis, numerous hedge funds were liquidated and several cases of financial fraud exposed. Design/methodology/approach Risk-adjusted return metrics such as the Sharpe ratio and Value at Risk were used to raise suspicion for fraud. These metrics, however, assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). Findings Results indicate that potential fraud would have been detected in the early stages of the scheme’s life. Having demonstrated the credibility of the bias ratio, it was then applied to several indices and (anonymous) South African hedge funds. The results were used to demonstrate the ratio’s scope and robustness and draw attention to other metrics which could be used in conjunction with it. Results from these multiple sources could be used to justify further investigation. Research limitations/implications The traditional metrics for performance evaluation (such as the Sharpe ratio), assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). The bias ratio, which does not rely on normally distributed returns, was applied to a known fraud case (Madoff’s Ponzi scheme). Practical implications The effectiveness of the bias ratio in demonstrating potential suspicious financial activity has been demonstrated. Originality/value The financial market has come under heightened scrutiny in the past decade (2005 – 2015) as a result of the fragile and uncertain economic milieu that still (2015) persists. Numerous risk and return measures have been used to evaluate hedge funds’ risk-adjusted performance, but many fail to account for non-normal return distributions exhibited by hedge funds. The bias ratio, however, has been demonstrated to effectively flag potentially fraudulent funds.

The Relationship between Hedge Fund Performance and Stock Market Sentiment

2018 ◽  
Vol 21 (03) ◽  
pp. 1850016 ◽  
Author(s):  
Yao Zheng ◽  
Eric Osmer
Keyword(s):  
Stock Market ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Investor Sentiment ◽  
Dynamic Effect ◽  
Fund Performance ◽  
Market Sentiment ◽  
Hedge Fund Returns ◽  
Hedge Fund Performance ◽  
The Relationship

We examine the dynamic effect of aggregate stock market sentiment on the performance of various hedge fund styles. We find that hedge funds typically perform better during periods of optimistic sentiment and that for different hedge fund styles there is a differential response of hedge fund returns to positive and negative sentiment shocks. We also find that changes in aggregate investor sentiment have a larger effect on hedge fund performance during periods of high conditional volatility. Our results suggest there is a strong asymmetry in the relationship between hedge fund performance and investor sentiment.

Portraits of five hedge fund fraud cases

2008 ◽  
Vol 15 (2) ◽  
pp. 179-213 ◽  
Author(s):  
Majed R. Muhtaseb ◽  
Chun Chun “Sylvia” Yang
Keyword(s):  
Asset Management ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Investment Fund ◽  
Good Opportunity ◽  
Content Type ◽  
Fund Managers ◽  
Management Group ◽  
Fund Industry ◽  
Asset Managers

PurposeThe purpose of this paper is two fold: educate investors about hedge fund managers' activities prior to the fraud recognition by the authorities and to help investors and other stakeholders in the hedge fund industry identify red flags before fraud is actually committed.Design/methodology/approachThe paper investigates fraud committed by the Bayou Funds, Beacon Hill Asset Management, Lancer Management Group (LMG), Lipper & Company and Maricopa investment fund. The fraud activities took place during 2000 and 2005.FindingsThe five cases alone cost the hedge fund investors more than $1.5 billion. Investors may have had a good opportunity for avoiding the irrecoverable costs of the fraud had they carefully vetted the backgrounds of the hedge fund managers and/or continuously monitored the funds activities, especially during turbulent market environments.Originality/valueThis is the first research paper to identify and extensively investigate fraud committed by hedge funds. In spite of the size of the hedge fund industry and relatively substantial level and inevitably recurring fraud, academic journals are to yet address this issue. The paper is of great value to hedge funds and their individual and institutional investors, asset managers, financial advisers and regulators.

MEASURING AND MONITORING THE EFFICIENCY OF MARKETS

2017 ◽  
Vol 20 (08) ◽  
pp. 1750051 ◽  
Author(s):  
DILIP B. MADAN ◽  
WIM SCHOUTENS ◽  
KING WANG
Keyword(s):  
Market Efficiency ◽  
Hedge Funds ◽  
Economic Activity ◽  
Hedge Fund ◽  
Exchange Traded Funds ◽  
Acceptability Index ◽  
Hedge Fund Returns

Market efficiency is measured by arbitrage proximity. The level of efficiency is calibrated by extent of a distortion of probability required to neutralize the drift. Simulations of bilateral gamma models estimated from past returns deliver for each asset on each day an empirical acceptability index. The assets covered include equities, commodities, currencies, volatility and hedge fund returns. It is observed that efficiency in equity is related to the process for up moves having more frequent and smaller jumps than its down side counterpart. For commodities the situation is reversed. Volatility indices trade more efficiently than equities, commodities, or currencies. Hedge fund returns reflect lower levels of efficiency supportive of hedge funds effectively exploiting market inefficiences. The relative inefficiency of the absence of trading is noted on comparing close to open with open to close returns. Small capitalization stocks trade more efficiently than the large ones. Sector exchange traded funds trade more efficiently than the S&P 500 index. Furthermore, economic activity reflected in greater high low spreads enhance market efficiency.

Current Hedge Fund Debates and Controversies

2017 ◽  
Author(s):  
Dianna C. Preece
Keyword(s):  
Insider Trading ◽  
Hedge Funds ◽  
Conflicts Of Interest ◽  
Hedge Fund ◽  
Securities And Exchange Commission ◽  
Active Management ◽  
Wall Street ◽  
Net Worth ◽  
Market Participants ◽  
Alternative Beta

The hedge fund industry has grown to nearly $3 trillion over the last 20 years. High-net-worth individuals and institutional investors expect high returns and low correlation with traditional asset classes in exchange for the fees paid. The standard fee structure is “2 and 20,” 2 percent of assets under management and 20 percent of profits, representing high fees for active management. Hedge funds are largely unregulated and somewhat mysterious. As a result, they are the subject of debates and controversies among market participants and policymakers alike. Debates focus on fee structures, alpha versus alternative beta, weakening returns, activist investors, and leverage. The Securities and Exchange Commission has targeted hedge fund misconduct and malfeasance, pursuing perpetrators of fraud, insider trading, and conflicts of interest in the industry. Several high-ranking Wall Street hedge fund executives have been charged with, and in some cases convicted of, breaking securities laws.

Hedge Fund Replication

2017 ◽  
Author(s):  
Mikhail Tupitsyn ◽  
Paul Lajbcygier
Keyword(s):  
Hedge Funds ◽  
Direct Investment ◽  
Tracking Error ◽  
Hedge Fund ◽  
Cost Effective ◽  
Secondary Markets ◽  
Hedge Fund Replication ◽  
Effective Manner ◽  
Equity Indices ◽  
Hedge Fund Returns

In theory, analogous to equity indices, hedge fund indices can provide broad exposure to hedge funds in a cost-effective manner. In practice, however, hedge fund indices are difficult to implement because direct investment in hedge funds is impractical. Unlike equities, hedge funds are not traded on liquid secondary markets and are often closed to new investment. A solution is hedge fund replication, which, rather than require direct investment in hedge funds, synthetically recreates hedge fund index returns by investing in portfolios that are exposed to the same underlying economic factors that drive hedge fund returns. This approach provides broad, cost-effective, hedge fund exposure and avoids the practical problems associated with direct hedge fund investment. As a consequence, such hedge fund clones exhibit lower tracking error and substantially higher raw and risk-adjusted returns than both investible and noninvestible hedge fund indices.

Fraud against hedge funds: implications to operational risk and due diligence

2020 ◽  
Vol 27 (1) ◽  
pp. 67-77
Author(s):  
Majed R. Muhtaseb
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Operational Risk ◽  
Future Research ◽  
Due Diligence ◽  
Law Firm ◽  
Short Term ◽  
Content Type ◽  
Fund Managers

Purpose The loss of an amount in excess of $100m cash deposit can be disruptive to the operations, definitely the liquidity of the hedge fund. Should a hedge fund liquidity position deteriorate, its compromised solvency could impact its vendors, most notably creditors and prime brokers. Large successful hedge funds do make basic mistakes. Lawyer Marc Dreier committed the criminal act of selling fraudulent promissory notes to hedge funds and others. Mr Drier’s success in selling fraudulent promissory notes was facilitated by his accomplices who posed as fake representatives of legitimate institutions. Drier and team presented bogus “audited financial statements” and forged developer’s signatures, and even went as far as using the unsuspecting institutions’ premises for meetings to meet potential notes buyers to further falsely legitimize the scheme. He had the notes buyers send their payments to his law firm account, to secure the money. His actions cost his victims, who include 13 hedge fund managers, other investors and entities, $400m in addition to his law firm’s employees who also suffered when his law firm was dissolved. For his actions, he was sentenced 20 years in federal prison for investment fraud. This study aims to direct hedge fund investors and other stakeholders to thoroughly vet the compliance function, especially controls on cash disbursements, even if the hedge fund is sizable (in excess of $1bn). Investors and even other stakeholders also should place a greater focus on what is usually overlooked issue; most notably the credit quality and authenticity of short-term investments bought by their hedge funds. Design/methodology/approach A thorough investigation of a fraud committed by a lawyer against a number of hedge funds. Several important lessons are identified to professionals who conduct due diligence on hedge funds. Findings The details of the case are very remarkable. This case directs investors’ attention to place greater efforts on certain aspects of operational risk and due diligence on not only hedge funds but also other investment managers. Normally investors conduct operational due diligence on the fund and its operations. Investors also vet fund external parties such as prime brokers, custodians, accountants and fund administrators. Yet, investors normally do not suspect the quality of short-term fund investments. In this case, the short-terms investments were the source of unforeseen yet substantial risk. Research limitations/implications Stakeholders in hedge funds need to carefully investigate the issuer of and the quality of short-term investments that a hedge fund invests in. Future research can investigate the association of hedge fund manager failure with a liquidity position of the fund. Practical implications Investors must thoroughly the entirety of the fund including short-term securities. Originality/value Normally, it is the hedge funds that commit the fraud against investors. In this case, it is the multi-billion hedge funds run by sophisticated fund managers, who are the victims.

Hedge Funds and Financial Misreporting

2021 ◽  
pp. 392-418
Author(s):  
Philippe Jorion
Keyword(s):  
Empirical Evidence ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Compensation System ◽  
Good News ◽  
Regulatory Environment ◽  
Due Diligence ◽  
Financial Misreporting ◽  
Hedge Fund Returns

The growth of the hedge fund industry can be ascribed to its performance-based incentive compensation system as well as a lighter regulatory environment. These features, however, could also potentially create more opportunities for financial misreporting and even fraud. In response, recent research has attempted to detect misreporting by using due diligence information or by examining patterns in hedge fund returns. Empirical evidence suggests that hedge fund fraud can be usefully predicted from due diligence information, especially evidence of previous misrepresentation. Predicting misreporting from hedge fund returns, however, is much more difficult. This is because returns may reflect patterns in underlying assets instead of manager manipulation. For hedge fund investors, the good news is that the accumulated body of experience about detecting misreporting should help improve the quality of hedge fund investments. In addition, newly-imposed registration requirements for hedge fund advisors should also lower occurrences of misreporting.

Hedge funds vs SEO firms: a comparative analysis

2017 ◽  
Vol 13 (1) ◽  
pp. 2-20 ◽  
Author(s):  
Robert Martin Hull ◽  
Sungkyu Kwak ◽  
Rosemary Walker
Keyword(s):  
Hedge Funds ◽  
Investment Decision ◽  
Hedge Fund ◽  
Optimal Investment ◽  
Seasoned Equity Offerings ◽  
Superior Performance ◽  
Content Type ◽  
Long Run ◽  
Portfolio Approach ◽  
Practical Implications

Purpose The purpose of this paper is to determine if hedge funds perform poorly as claimed by more recent research. The authors find hedge funds perform well from 2001 to 2013 when compared to sample of firms known to experience superior performance, namely, a sample of seasoned equity offerings (SEOs). Design/methodology/approach This paper uses a portfolio approach in comparing the performance of hedge funds and SEO firms. Other comparisons involve a number of common methodologies used to compute and analyze short-run and long-run returns. Findings Contrary to a growing and prevalent belief, the paper offers evidence hedge funds as a whole have performed well for a recent 13-year period. This finding includes periods up to six years around SEO announcement months. Research limitations/implications This paper is limited to examining monthly returns for a portfolio of hedge funds. This limitation led to incorporating a portfolio approach. Practical implications The findings suggest that a portfolio of hedge funds are an important investment consideration. This consideration has practical implications because investing in a portfolio of hedge funds has become more available for all investors in recent years. Social implications Society can be enhanced as this paper helps future investors make optimal investment decisions. Originality/value This paper adds to the hedge fund research by being the first paper to compare the performance of hedge funds with that for firms undergoing an important corporate event. The findings are new and can impact investment decision making.

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