Flows, Performance, and Managerial Incentives in Hedge Funds (original) (raw)

Flows, Performance, and Managerial Incentives in the Hedge Fund Industry

2003

This paper investigates the determinants of money-flows, nature of managerial incentives, behavior of investors, and drivers of performance in the hedge fund industry. It examines performance-flow relation and finds that funds with good recent performance, greater managerial incentives, and lower impediments to capital withdrawals experience higher money-flows. It also analyzes how current money-flows relate to future performance and finds that larger funds with greater inflows are associated with poorer future performance, a result consistent with decreasing returns to scale. It also finds that funds with greater managerial incentives are associated with superior future performance, justifying investors' preference for funds with higher managerial incentives. 5 Our finding of a convex performance-flow relation is consistent with that of , in the mutual fund industry.

On the Performance of Hedge Funds

Financial Analysts Journal, 1999

This paper investigates hedge fund performance and risk. The empirical evidence indicates that hedge funds differ substantially from traditional investment vehicles such as mutual funds. The funds with watermarks significantly outperform the funds without watermarks. The average hedge fund returns are related positively to incentive fees, the size of the fund, and the lockup period. Hedge funds follow dynamic trading strategies and have low systematic risk. There are low correlations among different strategies.

Investor Flows and Fund Restrictions in the Hedge Fund Industry

SSRN Electronic Journal, 2007

This paper studies the effect of share restrictions on the flow-performance relation of individual hedge funds. As such, we reconcile previous research that shows conflicting results for this relation. Specifically, we find that hedge funds exhibit a convex flow-performance relation in the absence of share restrictions (similar to mutual funds), but exhibit a concave relation in the presence of restrictions-our evidence is consistent with both a direct effect of restrictions and an indirect effect that is due to endogenizing of restrictions by investors. Further, we find that the "live database" exhibits a concave flow-performance relation due to capacity constraints, but that the "defunct database" displays a convex relation due to the extreme (good and bad) performing funds that populate this database. Finally, we find that money is smart, that is, fund flows predict future hedge fund performance; however, this smart money effect is reduced among funds with share restrictions.

Is Pay for Performance Effective? Evidence from the Hedge Fund Industry

SSRN Electronic Journal, 2011

Using voluntary decisions to limit investment, we investigate if the high payperformance sensitivities of hedge fund managers cause them to avoid overinvestment. Our results show that the primary objective of hedge fund managers is to hoard assets. We find that for funds closed to new investors, performance shifts from outperformance in the pre-closing period to average performance in the post-closing period. Funds that reopen are still too large to regain their outperformance. We also find that funds with higher outflow restrictions are less likely to close and experience a significantly higher performance loss over time. These results suggest that the high pay-performance deltas are not strong enough to prevent overinvestment and are offset by investor outflow restrictions.

The Life Cycle of Hedge Funds: Fund Flows, Size and Performance

2005

Since the 1980s we have seen a 25% yearly increase in the number of hedge funds, and an annual attrition rate of 7.10% due to liquidation. This paper analyzes the life cycles of hedge funds. Using the TASS database provided by the Tremont Company, it studies industry and fund specific factors that affect the survival probability of hedge funds. The findings show that in general, investors chasing individual fund performance decrease probabilities of hedge funds liquidating. However, if investors follow a category of hedge funds that has performed well, then the probability of hedge funds liquidating in this category increases. We interpret this finding as a result of competition among hedge funds in a category. As competition increases, marginal funds are more likely to be liquidated than funds that deliver superior risk-adjusted returns. We also find that there is a concave relationship between performance and assets under management. The implication of this study is that an optimal asset size can be obtained by balancing out the effects of past returns, fund flows, market impact, competition and favorable category positioning that are modeled in the paper. Hedge funds in illiquid categories are subject to high market impact, have limited investment opportunities, and are more likely to exhibit an optimal size behavior compared to those in more liquid hedge fund categories. , the seminar participants at Batterymarch Seminar, and the MIT Finance Student Lunch Group, for many stimulating discussions and comments.

Share Restrictions and Investor Flows in the Hedge Fund Industry

SSRN Electronic Journal, 2009

This paper studies the effect of share restrictions on the flow-performance relation of individual hedge funds. As such, we reconcile previous research that shows conflicting results for this relation without explicitly considering restrictions. Specifically, we find that hedge funds exhibit a convex flowperformance relation in the absence of share restrictions (similar to mutual funds), but exhibit a concave relation in the presence of restrictions-our evidence is consistent with both a direct effect of the binding restrictions and an indirect effect that is due to investors endogenizing expected future binding restrictions when investing their money. Further, we find that live funds exhibit a concave flow-performance relation due to stricter flow restrictions than defunct funds, which display a convex relation. Finally, we find that money is "smart," that is, fund flows predict future hedge fund performance; however, this "smart money" effect is eliminated among funds with greater share restrictions.

Reviewing the hedge funds literature I: Hedge funds and hedge funds' managerial characteristics

International Review of Financial Analysis, 2016

This paper summarizes the literature on hedge funds (HFs) developed over the last two decades, particularly that which relates to managerial characteristics (a companion piece covers the risk management characteristics of HFs). It classifies, the current HF literature, suggesting which critical problems have been "solved" and which problems have not been yet adequately addressed. It also discusses the effects of past financial regulation and the prospects for the effect of new financial regulation on the HF industry and its performance and risk management practices, and suggests new avenues for research. Furthermore, it highlights the importance of managerial characteristics for HF performance, and the successes and the shortfalls to date in developing more sophisticated HF-related risk management tools.

Hedge Funds: Performance, Risk, and Capital Formation

The Journal of Finance, 2008

Hedge Funds: Performance, Risk and Capital Formation* We use a comprehensive dataset of Funds-of-Hedge-Funds (FoFs) to investigate performance, risk and capital formation in the hedge fund industry over the past ten years. We confirm the finding of high systematic risk exposures in FoF returns. We divide up the past ten years into three distinct subperiods and demonstrate that the average FoF has only delivered alpha in the short second period from October 1998 to March 2000. In the cross section of FoFs, however, we are able to identify FoFs capable of delivering persistent alpha. We find that these more successful hedge funds experience far greater (and steadier) capital inflows than their less fortunate counterparts. Berk and Green's (2004) rational model of active portfolio management implies that diminishing returns to scale combined with the inflow of new capital leads to the erosion of superior performance over time. In keeping with this implication, we provide evidence that even successful hedge funds have experienced a recent, dramatic decline in risk-adjusted performance.

Hedge Fund Performance: Sources and Measures

International Journal of Theoretical and Applied Finance, 2009

The concept of the gamma of a financed return as the highest level of stress that a return distribution can withstand is introduced. Stress is measured by positive expectation under a concave distortion of the return distribution accessed. Four distortions introduced in Cherny and Madan (2008) are employed in studying the distribution of returns available in the hedge fund universe. It is shown that the skewness, peakedness and tailweightedness of the standardized investment return significantly affects the Sharpe ratios required to reach a target gamma level.