Imperial College London’s new hedge fund performance research is debated
Dr. Robert Kosowski, Director of the Risk Management Laboratory of the Imperial College Business School, has presented as yet unpublished evidence showing that young funds perform better than old funds.
Speaking at the Peregrine Perspectives Age vs Performance discussion forum, held in association with Imperial College Business School, Professor Kosowski noted that, “Overall, hedge funds with greater managerial incentives, smaller funds and younger funds outperform while hedge funds with strict share restrictions – such as notice, redemption and lockup periods – are not always associated with higher risk-adjusted returns.”
Professor Kosowski and his colleagues at the Imperial College Business School’s Centre for Hedge Fund Research created a comprehensive aggregate hedge fund database and examined key performance drivers, evidence of performance persistence and the effects of data biases.
The research shows that several of the established beliefs about hedge funds are actually sensitive to the choice of database. The results do not replicate in the comprehensive database created by Imperial, that aggregated data from the five main commercially available hedge fund databases for the period 1994-2010.“Aggregating the five main commercially available databases shows that databases coverage is highly non-overlapping and two thirds of all fund share classes are covered only by one of the databases,” Professor Kosowski noted.
He added: “There is evidence of significant positive risk-adjusted performance of the average fund while differences in its magnitude are due to differences in fund size, domicile and data biases, but not differences in fund risk exposures.”
Also on the ‘Age vs. Performance’ discussion panel were David Yim, a Director of KPMG in London; Anne-Sophie d’Andlau, Managing Partner of CIAM, a Paris-based hedge fund start-up focused on merger arbitrage; and Jeroen Tielman, Founder and CEO of IMQ Investment Management, which runs the IMQubator hedge fund seeding platform. Anthony Payne, Founder and Group CEO and founder of Peregrine Communications, chaired the discussion.
“Barriers to entry from regulation and institutionalization will impact the rate of new start-ups,’ explained Yim. “Moreover, managers with assets of less than US$100m will find it increasingly challenging to run a long term business as a result of increased costs from regulation. There is evidence of a next generation of talent migrating from brand name investment houses to set up new hedge fund businesses. Whilst the industry continues to institutionalize, the allure of reward, creativity and freedom on offer from the boutique sector will always attract alpha generators. Hence, the number of boutiques will continue to thrive, although in capital terms, they will represent a far smaller proportion of the industry.”
Speaking from the perspective of a new manager, d’Andlau said of the CIAM fund,“The fundamental principles of CIAM are transparency, liquidity, and asymmetrical returns versus global financial markets. Investors are drawn to merger arbitrage strategies as a way of diversifying portfolios away from equities and bonds. Because we are a young firm, we have learned how to bring together our portfolio and risk management. We are looking to generate 10% returns in 2012.”
Tielman added: “IMQubator’s mission is to realise solid absolute returns at low cost by investing in nimble and innovative funds and strategies, while delivering the emerging manger premium. IMQubator’s focus is on absolute return oriented managers with asymmetric return profiles and strong risk discipline. Alpha generation is key for investors and early stage managers can provide that in abundance.”
Peregrine Perspectives Event – 27 March 2012
Age vs. Performance
NOTES TO EDITORS
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About Imperial College Business School
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About the Research
Professor Robert Kosowski from Imperial College London and his co-authors at the Imperial’s Centre for Hedge Fund Research created one of the most comprehensive aggregate hedge fund databases and examined (i) key performance drivers, (ii) evidence of performance persistence and (iii) the effects of data biases (Joenväärä, Kosowski and Tolonen, 2012).
Their research provides novel insights and shows that several of the established stylised facts about hedge funds are sensitive to the choice of database and do not obtain in the aggregate database that aggregates the five main commercially available hedge fund databases for the period 1994-2010. By highlighting the effect of database differences on previously documented results the authors aim to improve the ability of researchers in this literature to compare results across different studies.
The authors aim to update the analysis online several times a year based on the latest data to inform the discussion about stylised facts about hedge funds.
- Aggregating the five main commercially available databases shows that databases coverage is highly non-overlapping and two thirds of all fund share classes are covered only by one of databases. This highlights the need for a comprehensive aggregate database.
- There is evidence of significant positive risk-adjusted performance of the average fund while differences in its magnitude are due to differences in fund size, domicile and data biases, but not differences in fund risk exposures.
- The magnitude of risk-adjusted returns differs across databasesOverall, hedge funds with greater managerial incentives, smaller funds and younger funds outperform while hedge funds with strict share restrictions (such as notice, redemption and lockup periods) are not always associated with higher risk-adjusted returns
- Small funds perform better than large funds in all data bases and all hedge fund styles
- Since the coverage of small funds differs by data base, the average performance and evidence of performance persistence is weaker in data bases with a few small funds
- Young funds perform better than old funds
- Onshore funds perform better than offshore funds
- As a result of the importance of small funds and differences in backfill bias between data bases, value-weighted indices show lower average performance than equal-weighted performance
- The coverage of AuM (Assets under Management) information differs significantly between data bases and implies differences in value-weight and equal weight indices.
- Measures of misreporting and return smoothing by funds are similar across different data bases
- Evidence of performance persistence differs across databasesThe results highlight the importance of drawing inference about hedge fund performance using a comprehensive aggregate hedge fund data base.
- Performance persistence tests examine the out-of-sample performance of top and bottom funds. There is evidence of statistically significant performance persistence in the aggregate data base.
- Performance persistence is sensitive to share restrictions, rebalancing frequency, fund size and weighting scheme as well as more pronounced biases in certain databases.
- Some data bases suffer from a significant backfill bias and low fund attrition rates. In persistence tests the resulting omission of poorly performing funds leads to an insignificant out-of-sample performance spread between top and bottom funds in two of the five individual data bases