1、Hedge Fund Market Neutral Strategies:Distinguishing Financial and Operational Risk FactorsStephen J.BrownNYU SternThe Joint 14th Annual PBFEAThe Joint 14th Annual PBFEAand 2006 Annual and 2006 Annual FeATFeAT Conference Conference 第十四屆亞太財務經濟及會計會議暨第十四屆亞太財務經濟及會計會議暨2006台灣財務工程學會聯合研討會台灣財務工程學會聯合研討會Disting
2、uishing operational and financial riskHistorical perspectiveOperational riskCharacterized by conflicts of interestFinancial riskThe myth of market neutralityRobust measure of tail risk neutralityConclusionThe History of Hedge Funds The first hedge fund:Alfred Winslow Jones(1949)Limited Partnership(e
3、xempt from 40 Act)Long-short strategy20%of profit,no fixed feeUsed short positions and leverage“Hedge Fund”(Fortune magazine 1966)Tiger Fund(Institutional Investor 1986)George Soros$3.2Billion raid on the ERM(1992)CalPERS(2000)Institutional concern about riskFiduciary guidelines imply concern for ri
4、skFinancial riskOperational risk Institutional demandGrowing popularity of market neutral stylesExplosive growth of funds of fundsDemand for“market neutral”funds of fundsOperational RiskSource:Tremont TASS(Europe)LimitedHedge fund failure is highly predictable Measuring operational riskSEC registrat
5、ion requirement(Feb 2006)2270 of TASS Funds that registeredHad better past performanceHad larger assets under management15.8%had prior legal/regulatory problemsWhat are the correlates of operational risk?Correlates of operational risk“Problem”Funds“Non-Problem”FundsNMeanMedianNMeanMedianDiffAvg Retu
6、rn3560.890.80 18980.980.84-0.09*Std Dev3542.601.7918972.742.08-0.14Sharpe Ratio3540.330.2918970.390.30-0.06*AUM($mm)325218.258.741647180.254.0038.00Age(Years)3585.654.5019124.993.920.66*Management Fee(%)3581.371.2519121.381.50-0.01External conflictsProblem fundsNon problemfundsWith:N%YesN%YesBroker/
7、Dealer35973.8191224.8Investment Comp35950.4191216.0Investment Advisor35974.7191241.3Commodities Broker35953.5191220.3Bank35940.419129.8Insurance35939.819129.4Sponsor of LLP35956.8191222.2Internal conflictsProblem fundsNon problemfundsWith:N%YesN%YesTrade securities with clients35930.119128.4Allow tr
8、ading on own account35985.2191269.6Recommend own securities35974.9191250.8In-house broker dealer35931.219122.3Recommends own underwriting service35969.4191246.8Recommends commission fee items35922.6191215.7Recommends brokers35945.7191238.4Use broker provided external research35981.3191269.9Towards a
9、 univariate index of operational riskTASS VariablesSEC VariablesPrevious Returns-0.27In-house broker dealer0.06Previous Std.Dev.-0.36Associated with broker dealer0.24Fund Age-0.10Investment company association0.25Log of Assets0.09Investment advisor association0.24Reports Assets0.07Commodity trader a
10、ssociation0.44Incentive Fee-0.89Associated with bank or thrift0.39Margin-0.29Associated with insurance co0.42Audited-0.21Associated with ltd.partner syndicator0.27Personal Capital-0.26Trade securities with clients0.06Onshore-0.11Allow trading on own account-0.12Open to Inv.0.04Recommend own securiti
11、es0.32Accepts Managed Accts-0.13Recommends own underwriting service0.24Recommends commission fee items0.28Recommends brokers-0.35Use broker provided external research-0.69Financial RiskSource:Elton and Gruber 1995.Risk is measured relative to the standard deviation of the average stockFinancial Risk
12、Caught by the tail“S&P500 returns at Treasury Bill risk”Most new funds claim to be“market neutral”Zero correlation with benchmark Zero correlation is not a strategyZero correlation is an outcome of a strategy These strategies fail in liquidity crisesRisk is considerably understated New concept:“tail
13、 risk neutrality”A market neutral strategyDataTASS hedge funds both dead and aliveUS funds with at least 10 returns,average of 40 max of 120.Not a lot of data per fund,but plenty when the universe is combined nearly 50,000 fund-month observations.An example of market neutralityFund ReturnsMarket Ret
14、urns0.20.20.40.60.80.60.80.41.5%1.1%0.8%0.4%Beta=.28,rho=.24Assuming MVN returns2.5%1.9%1.3%0.6%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=.28,rho=.24Market neutrality in the real worldUsing TASS data2.5%1.9%1.3%0.6%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=.28,rho=.24Market
15、 neutrality in the real worldLong Short Equity Funds2.9%2.2%1.3%0.6%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=.50,rho=.37Event driven style3.1%2.3%1.5%0.8%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=.20,rho=.23Dedicated Short Sellers4.5%3.4%2.3%1.1%Fund Returns0.20.40.60.8S&P
16、500 Returns0.20.60.80.4Beta=-.91,rho=-.61Fixed income arbitrage1.5%1.1%0.8%0.4%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=0.01,rho=0.02Funds of Hedge FundsH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds
17、sFunds of Hedge FundsProvidesH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds sFunds of Hedge FundsProvidesDiversification lower value at riskH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed
18、 dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds sFunds of Hedge FundsProvidesDiversification lower value at riskSmaller unit size of investmentH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds sFunds of Hed
19、ge FundsProvidesDiversification lower value at riskSmaller unit size of investmentProfessional management/Due diligenceH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds sFunds of Hedge FundsProvidesDiversification low
20、er value at riskSmaller unit size of investmentProfessional management/Due diligenceAccess to otherwise closed fundsH H e ed dg ge e F Fu un nd d 1 1H H e ed dg ge e F Fu un nd d 2 2H H e ed dg ge e F Fu un nd d 3 3F Fu un nd d o of f F Fu un nd ds sInstitutions love FoFSpectacular growth of Funds o
21、f Funds2000:15%of all Hedge funds were FoF2003:18%of all Hedge funds were FoF2005:27%of all Hedge funds were FoFInstitutional attraction of Funds of FundsRisk managementDue diligenceFunds of Funds2.9%2.2%1.3%0.6%Fund Returns0.20.40.60.8S&P500 Returns0.20.60.80.4Beta=.14,rho=.22Relationship to LIBOR1
22、.0%0.8%0.5%0.3%Fund Returns0.20.40.60.8LIBOR return0.20.60.80.4Beta=0.0,rho=0.0Fixed income arbitrage2.0%1.5%1.0%0.5%Fund Returns0.20.40.60.8LIBOR return0.20.60.80.4Beta=-.02,rho=-.05Simple measures of tail risk exposureIndependence an unrealistic benchmarkConsiderMV Normal with the same sample corr
23、elationMV Student with 3 dfSimple measures of tail risk exposureIndependence an unrealistic benchmarkConsiderMV Normal with the same sample correlationMV Student with 3 df0.240.0188An example of market neutralityFund ReturnsMarket Returns0.20.20.40.60.80.60.80.41.5%1.1%0.8%0.4%Beta=.28,rho=.24Assumi
24、ng MVN returnsAn example of market neutralityFund ReturnsMarket Returns0.20.20.40.60.80.60.80.41.5%1.1%0.8%0.4%Beta=.28,rho=.24WWLWWLLLLL should be 1.88%of sample assuming MVN returnsComparison with S&P500 BenchmarkCorrelation with benchmarkBinomial Crashp-value(ind)p-value(N)p-value(t)All Funds0.28
25、*000Funds of Funds0.14*000Convertible Arbitrage0.09*00.0330.840Dedicated Short Bias-0.91*0.9970.1120.838Emerging Markets0.66*00.0310.394Equity Market Neutral0.020.0010.0060.893Event Driven0.20*000Fixed Income Arbitrage0.010.3950.4800.995Global Macro0.080.0040.0340.752Comparison with LIBOR BenchmarkC
26、orrelation with benchmarkBinomial Crashp-value(ind)p-value(N)p-value(t)All Funds0.00111Funds of Funds0.01111Convertible Arbitrage0.00000.074Dedicated Short Bias0.070.0060.0310.432Emerging Markets-0.17*0.9950.8231Equity Market Neutral0.07*0.1480.5671Event Driven-0.04*111Fixed Income Arbitrage-0.05000
27、.007Global Macro-0.030.8490.7560.999Logit SpecificationBoyson,Stahel and Stulz 2006 suggest running logit regressions of whether a fund index crashes in a month upon the market return and a dummy for market crashes.A positive coefficient on the dummy indicates additional dependence during crashes.La
28、cks power when run on a single index.We run the regressions on the cross-section.ConclusionsOperational riskImportant role for due diligenceCharacterized by internal and external conflicts of interestFinancial riskUndiversifiable crash risk lurks in hedge fund returns,despite their seemingly light dependence in normal times.
