Hedge Funds: Gross Leverage Rose While Net Leverage FellGuest Post
Skanderbeg Asset Management’s Put into Perspective newsletter for the month of April 2020.
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” – William Arthur Ward
Exposures: Overall book grosses and nets fell, while fundamental LS nets rose slightly amid long buys
Gross leverage rose while net leverage fell as sharp price rally was balanced by long-and-short sales
Institutional investors and hedge fund activism
Rutgers Business School
University of Texas at Austin – Department of Finance
Southwestern University of Finance and Economics (SWUFE); Rutgers, The State University of New Jersey – Rutgers Business School at New- ark & New Brunswick
Abstract: Hedge fund activists have ambiguous relationships with the institutional shareholders in their target firms. While some support their activities, others counter their actions. Due to their relatively small holdings in target firms, the activists typically need the cooperation of other institutional shareholders that are willing to influence the activist’s campaign success. We find the presence of “activism-friendly” institutions as owners is associated with an increased probability of being a target, higher long-term stock returns, and higher operating per- formance. Overall, we provide evidence suggesting the composition of a firm’s ownership has significant effects on hedge fund activists’ deci- sions and outcomes.
The hedge fund industry is bigger (and has performed better) than you think
Board of Governors of the Federal Reserve System
Aalto University School of Business
Mikko Kauppila University of Oulu
University of Maryland – Robert H. Smith School of Business; European Corporate Governance Institute (ECGI)
Abstract: Of first-order importance to the study of potential systemic risks in hedge funds is the aggregate size of the industry. The world- wide hedge fund industry has been estimated by regulators and industry experts as having total net assets under management of $2.3-3.7 trillion as of the end of 2016. Using a newly combined database of several hedge fund information vendors, augmented by the first detailed, systematic regulatory collection of data on large hedge funds in the United States, we estimate that the worldwide net assets under manage- ment were at least $5.2 trillion in 2016, over 40% larger than the most generous estimate. Gross assets, which represent the balance sheet value of hedge fund assets, exceeds $8.5 trillion. We further decompose hedge fund assets by their self-reported strategy and by fund domi- cile. We also show that the total returns earned by funds that report to the public databases are significantly lower than the returns of funds that report only on regulatory filings, both in aggregate and within nearly every fund strategy. This difference appears to be driven entirely by alpha, rather than by differences in exposures to systematic risk factors. However, net investor flows are considerably higher for funds re- porting publicly, suggesting previous estimates of the flow-performance relationship are likely biased. Our new, and much larger, estimates of the size of the hedge fund industry should help regulators and prudential authorities to better gauge the systemic risks posed by the in- dustry, and to better evaluate potential data gaps in private funds. Our results also suggest that systematic risk is roughly similar in publicly and non-publicly reporting funds.
Leverage and risk in hedge funds
Board of Governors of the Federal Reserve System
Office of Financial Research, US Department of the Treasury
Government of the United States of America, Department of the Treasury, Office of Financial Research
Abstract: The use of leverage is often considered a key potential systemic risk in hedge funds. Yet, data limitations have made empirical anal- yses of hedge fund leverage difficult. Traditional theories predict leverage and portfolio risk are positively linearly related. Alternatively, an emerging wave of theories of leverage constraints predict leverage and asset risk are negatively correlated, and therefore leverage and port- folio risk may be unrelated or even negatively related. Consistent with theories of leverage constraints, we find that hedge fund leverage and portfolio risk are weakly negatively correlated. This arises from a strong negative association between leverage and asset risk — in particular, market beta. The average market beta on funds’ assets explains 20% of the cross-sectional variation in hedge fund leverage, and 47% for the subsample of equity-style funds. Also consistent with these theories, leverage and portfolio alpha are strongly positively related, but this relationship is entirely explained by market beta. Our findings suggest that the association between leverage and risk in hedge funds is nu- anced, and that leverage is in part used to scale the payoffs of low-beta, high-alpha securities, resulting in an essentially flat relationship be- tween leverage and portfolio risk.
Read the full article here.