Hedge Funds: Performance, risk and capital formation

1
Hedge Funds Performance, risk and capital
formation

• William Fung
• David A. Hsieh
• Narayan Y. Naik
• Tarun Ramadorai
• Discussant
• Stephen J. Brown NYU Stern School of Business
• www.stern.nyu.edu/sbrown

2
Major contributions of paper

• Heterogeneity among funds of funds
• Fund flow based on relative, not absolute return
• Fund flow leads to an erosion of performance
• Strong support for Berk and Green hypothesis
• Triumph of mediocrity in fund performance

3
Substantial growth of funds of funds
All TASS US Funds of Funds
4
Substantial growth of funds of funds
All TASS US Funds of Funds
5
Relative performance of Funds of Funds
Source CRSP and CISDM
6
Considerable heterogeneity among funds of funds
Mean 187.6 Million
Median 62.6 Million
All TASS US Funds of Funds December 31, 2005
7
The Myth of Market Neutrality

• Market neutrality is not a strategy
• It is an outcome of a strategy
• Hedge funds have significant market exposure
• Fung and Hsieh (2003)
• Smart money follows alpha

8
The Triumph of Mediocrity
Secrist, H. (1933). The Triumph of Mediocrity in
Business. Bureau of Business Research,
Northwestern University, p.176.
9
The Failure of Mediocrity?
Secrist, H. (1933). The Triumph of Mediocrity in
Business. Bureau of Business Research,
Northwestern University, p.176.
10
Diseconomies of Scale?
Prior month assets under management Prior month assets under management Prior month assets under management Prior month assets under management Prior month assets under management Prior month assets under management Prior month assets under management
1st quintile 2nd quintile 3rd quintile 4th quintile 5th quintile All Funds t-value (large - small) t-value (large - small)
Funds of Funds 7.31 9.12 8.61 9.77 10.28 10.08 2.56 2.56
Funds of Funds 0.119 0.183 0.220 0.272 0.310 0.201
All hedge funds 13.74 14.11 12.39 11.16 10.72 10.97 -1.69 -1.69
All hedge funds 0.134 0.174 0.177 0.173 0.170 0.160
All TASS US Funds 1995-2004. Value weighted
returns, Sharpe ratio in italics
11
Conclusion

• Paper provides strong evidence
• Heterogeneity among funds of funds
• Funds flow to alpha, not absolute return
• A triumph of mediocrity?
• Evidence of diseconomies of scale is mixed