Current Hedge Fund Issues

Current Hedge Fund Issues

Hedge Funds: Performance, risk and capital formation William Fung David A. Hsieh Narayan Y. Naik Tarun Ramadorai Discussant Stephen J. Brown www.stern.nyu.edu/~sbrown NYU Stern School of Business 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 Substantial growth of funds of funds 800

Number of Funds 700 600 500 400 300 200 100 0 1/31/1995 1/30/1997 1/31/1999 1/30/2001 1/31/2003

All TASS $US Funds of Funds 1/30/2005 Substantial growth of funds of funds $120 AUM ($US Billion) $100 $80 $60 $40 $20 $0 1/31/1995 1/30/1997 1/31/1999

1/30/2001 1/31/2003 All TASS $US Funds of Funds 1/30/2005 Relative performance of Funds of Funds 6 Value (1900 = $1) 5 4 CRSP Value Weighted Market 3

CISDM Fund of Funds index 2 1 0 19 19 1 1 2 2 1 2 90 99 94 996 998 00 00 00 2 2 4 0

Source: CRSP and CISDM Considerable heterogeneity among funds of funds 0.14 0.12 0.1 Mean $187.6 Million Median $62.6 Million 0.08 0.06 0.04 0.02 0 $0

$1,000 $2,000 $3,000 $4,000 AUM ($US Million) All TASS $US Funds of Funds December 31, 2005 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

The Triumph of Mediocrity Secrist, H. (1933). The Triumph of Mediocrity in Business. Bureau of Business Research, Northwestern University, p.176. The Failure of Mediocrity? Secrist, H. (1933). The Triumph of Mediocrity in Business. Bureau of Business Research, Northwestern University, p.176. Diseconomies of Scale? Prior month assets under management 1st 2nd 3rd 4th

5th All qui quintil quintil quintil quintil Funds ntil e e e e e Funds of 7.31% 9.12% 8.61% Funds 0.119 0.183 0.220 9.77% 10.28 % 10.08

% 0.272 0.310 0.201 t-value (large small) 2.56 13.74 14.11 12.39 10.72 10.97 All 11.16% -1.69 % %

% % % hedg e 0.134 0.174 0.177 0.173 0.170 0.160 funds All TASS $US Funds 1995-2004. Value weighted returns, Sharpe ratio in italics 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

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