- Hedge funds managed by listed companies underperform those managed by unlisted ﬁrms by a statistically significant 1.9% per year (t-statistic = 3.1).
- After adjusting for factor exposures, hedge funds managed by listed ﬁrms underperform hedge funds managed by unlisted ﬁrms by 2.89% per year (t-statistic = 4.7).
- The results are not confined to the smallest funds and cannot be explained by differences in share restrictions, illiquidity or other issues examined.
- The underperformance of funds managed by listed ﬁrms is not peculiar to a particular year.
- Relative to the ﬁve-year pre-IPO period, average fund risk-adjusted performance deteriorates by an annualized 8.40%, and average ﬁrm alpha wanes by an annualized 7.20%. The results are statistically significant at the 1% level.
- Funds that have the greatest scope for asset gathering, as a consequence of their low liquidity risk levels, also exhibit the most severe underperformance.
- Among listed ﬁrms, those with low insider ownership and whose IPO prospectuses reveal that existing shareholders cash out underperform more.
- Despite the poor performance, relative to the control group, public ﬁrms are able to grow their AUM by 78% during the same period. The surge in ﬁrm AUM stems both from organic growth in existing fund AUM and from the launch of new funds post listing—suggesting that the new capital raised goes toward the marketing of existing and new products.
- Firms are more likely to raise additional funds post IPO—listing increases the chance that a ﬁrm will raise a new fund by almost a third.
Sun and Teo concluded: “The results in this paper challenge the view that asset management ﬁrms list to enhance investment performance.” They added: “Our ﬁndings indicate that the process of going public heightens conﬂicts of interest, which are in turn associated with poorer performance”—the drive to increase AUM trumps performance.
Importantly, the authors noted that the underperformance is driven by listed ﬁrms whose existing shareholders cashed out during the IPO: “After adjusting for risk, funds managed by listed ﬁrms in which existing shareholders cashed out underperform funds managed by unlisted ﬁrms by 4.58% per year (t-statistic = 2.86), and those managed by listed ﬁrms in which existing shareholders did not cash out under-perform their unlisted competitors by a modest 0.27% per year (t-statistic = 0.35).”
The hedge fund industry has been destroying returns now for over a decade. To make matters worse, Sun and Teo demonstrate that the conﬂicts of interest at hedge funds managed by listed ﬁrms translates into a tendency to raise capital by growing the AUM of existing and new products—which, in turn, leads to underperformance.
Funds that have the greatest scope for asset gathering, as a consequence of their low liquidity risk levels, exhibit the most severe underperformance. Forewarned is forearmed.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.