2018 was another very poor year for hedge fund investors, with the HFRX Global Hedge Fund Index losing 6.7%. That comes after a decade over which the index underperformed every major global equity index and bond index—losing 0.4% from 2008 through 2017.
Lin Sun and Melvyn Teo contribute to the literature on the performance of hedge funds with their study “Public Hedge Funds,” which appears in the January 2019 issue of the Journal of Financial Economics. The recent public listings by giant hedge fund management ﬁrms (including Amundi, Man Group, Och-Ziff Capital Management Group, The Blackstone Group and KKR & Co.) led them to investigate whether the performance of publicly owned hedge funds differed from the performance of privately owned ones. Specifically, they examined how the performance changed in the post-IPO period.
Sun and Teo noted: “The fund management companies argue that going public allows them to enhance investment performance by better incentivizing their staff through employee stock options and by investing the initial public offering (IPO) proceeds in superior technology and business support.”
They also noted that being public brings more transparency. The counterargument made by fund investors, the authors wrote, is that, “Public listing allows ﬁrm founders to sell off their stakes to outsiders, which exacerbates potential conﬂicts of interest. For asset managers, the transition to public markets weakens the alignment between ownership, control, and investment capital, engendering a rich combination of agency problems.”
One key issue is that post-IPO, the founders of the ﬁrm sell out to new shareholders, who typically do not invest alongside the limited partners. Thus, their focus may not be on performance but on growth of fund assets (and the fees that go with that growth). And with growth comes concerns over diseconomies of scale.
Sun and Teo evaluated hedge funds using monthly net-of-fees returns and assets under management (AUM) data of live and dead hedge funds reported in the TASS, Hedge Fund Research (HFR) and BarclayHedge data sets from January 1994 to December 2013. Their data set included a total of 16,592 hedge funds—5,947 live funds and 10,645 dead funds at the end of the period. Note that there were 80% more dead than live funds at the end of the period, highlighting the poor performance of most hedge funds and the importance of addressing the issue of survivorship bias in the data.
They examined risk-adjusted returns based on the seven Fund and Hsieh factors, which have been found to have strong explanatory power for hedge fund returns (the excess return on the S&P 500 Index; a small minus big factor constructed as the difference between the Russell 2000 and the S&P 500 indexes; the yield spread of the U.S. 10-year Treasury bond over the three-month Treasury bill, adjusted for duration of the 10-year bond; the change in the credit spread of Moody’s BAA bond over the 10-year Treasury bond, also appropriately adjusted for duration of the 10-year bond; and the excess returns on portfolios of lookback straddle options on currencies, commodities and bonds).
Following is a summary of their findings: