Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis

Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.

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

Studies in Economics and Finance ◽

10.1108/sef-10-2017-0289 ◽

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.

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MEASURING AND MONITORING THE EFFICIENCY OF MARKETS

International Journal of Theoretical and Applied Finance ◽

10.1142/s0219024917500510 ◽

2017 ◽

Vol 20 (08) ◽

pp. 1750051 ◽

Cited By ~ 14

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.

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Relative Value Hedge Funds: A Behavioral Modeling of Hedge Fund Risk and Return Factors

Journal of Behavioral Finance ◽

10.1080/15427560.2018.1434654 ◽

2018 ◽

Vol 19 (4) ◽

pp. 462-482

Author(s):

L. Mick Swartz ◽

Farrokh Emami-Langroodi

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Behavioral Modeling ◽

Risk And Return ◽

Relative Value ◽

Return Factors ◽

Hedge Fund Risk

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Hedge Fund Replication

10.1093/oso/9780190607371.003.0025 ◽

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.

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Event-Driven Hedge Fund Strategies

10.1093/oso/9780190607371.003.0012 ◽

2017 ◽

Author(s):

Caroline Farrelly ◽

François-Serge Lhabitant

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Skill Sets ◽

Broad Category ◽

Event Driven ◽

Arbitrage Trading ◽

Merger Arbitrage ◽

Time Frames ◽

Legal Expertise

This chapter explores some of the strategies used by event-driven hedge funds, namely merger arbitrage, trading distressed securities, special situations, and activism. This broad category within the hedge fund space attracts about a quarter of the capital deployed to this part of the alternatives world. Investors are drawn to the idea of uncorrelated returns that can act as a source of diversification for their portfolios as well as the ability to follow the news flow related to their investments. In essence, such trades should have identifiable catalysts and time frames. The chapter offers illustrative examples of historical trades, providing some context of the types of positions funds may take and time frames involved. Various skill sets should be sought in an event-driven manager. Managers dealing in distressed securities are likely to benefit from a legal expertise, whereas activists need to be able to influence management and campaign publically.

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Hedge Fund Strategies in the Post-Crisis Era

10.1093/oxfordhb/9780198840954.013.24 ◽

2021 ◽

pp. 135-159

Author(s):

Yigit Atilgan ◽

Turan G. Bali ◽

A. Doruk Gunaydin

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Abnormal Returns ◽

Bond Market ◽

Market Portfolio ◽

Relative Value ◽

Pricing Factors ◽

Merger Arbitrage ◽

Arbitrage Strategy ◽

Risk Ratios

This chapter examines the performances of various hedge fund strategies based on various reward-to-risk ratios after the 2008 global crisis. We document that a majority of hedge fund strategies deliver lower average returns compared to equities and bonds; yet the volatilities of their returns have also been low. The equity hedge strategy has the highest reward-to-risk ratios among the major strategy categories, whereas the relative value arbitrage strategy has the lowest. Technology/healthcare, merger arbitrage, discretionary thematic, and asset-backed arbitrage strategies tend to have the highest reward-to-risk ratios in their respective categories. Time-series regressions of hedge fund strategy returns on various fund pricing factors provide evidence that hedge funds, on average, do not generate abnormal returns once the pricing factors are controlled for. We also document that hedge fund strategy returns generally load negatively on the bond market and aggregate credit risk factors and positively on the market portfolio.

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Investment Strategies of Hedge Funds

10.1093/oxfordhb/9780198840954.013.9 ◽

2021 ◽

pp. 112-135

Author(s):

Hany A. Shawky

Keyword(s):

Capital Structure ◽

Hedge Funds ◽

Yield Curve ◽

Hedge Fund ◽

Investment Strategies ◽

Fixed Income ◽

Relative Value ◽

Merger Arbitrage ◽

Arbitrage Strategy ◽

And Performance

This chapter reviews a number of different hedge fund strategies, including equity hedge, long/short, market neutral, relative value arbitrage, convertible arbitrage strategy, capital structure arbitrage strategy, fixed income arbitrage strategy, yield curve arbitrage strategy, other relative value arbitrage strategies, emerging markets strategies, global macro strategies, event driven strategies, distressed securities, and merger arbitrage strategies. In addition, the author discusses the growth and performance of different strategies, as well as fraud, fund failures, activism, and regulation.

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Hedge Funds and Financial Misreporting

10.1093/oxfordhb/9780198840954.013.20 ◽

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.

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Hedge Funds: Do They Do What They Say They Do?

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v8i10.769 ◽

2010 ◽

Vol 8 (10) ◽

Author(s):

Scott P. Mackey ◽

Michael R. Melton

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Strongly Correlated ◽

Ample Evidence ◽

Investment Style ◽

Funds Of Hedge Funds ◽

Standard Linear ◽

Style Indices ◽

Fund Investment ◽

Hedge Fund Returns

The purpose of this research is two-fold, to determine if hedge funds follow their stated strategy styles and to examine how hedge funds’ strategy allocations evolve over time in response to changed economic and market conditions.  Our key advance is that we show that standard linear style models like that of Sharpe (1992) can be applied to hedge fund returns as long as the returns of the style indices in the model themselves display the nonlinear option-like characteristics of hedge fund returns.  For our research, the returns of our sample of Funds of Hedge Funds are strongly correlated to the returns of portfolios of hedge fund investment style indices.  In this way, we capture the spirit of Fung & Hsieh's (2002) Asset-Based Style Factors for Hedge Funds.  Based on our results, it appears that the answer to the first question is “somewhat”, while we find ample evidence of significant shifts in allocation among the Fund of Hedge Funds from the first sample period (1997-2001) to the second (2002-2006).  The changes in allocation appear to rationally reflect the changed economic conditions and investment opportunities existing at the time.

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Flagging potential fraudulent investment activity

Journal of Financial Crime ◽

10.1108/jfc-09-2015-0051 ◽

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.

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