Side-by-Side Management of Hedge Funds and Mutual Funds

  • 569 views
Uploaded on

 

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Be the first to comment
    Be the first to like this
No Downloads

Views

Total Views
569
On Slideshare
0
From Embeds
0
Number of Embeds
0

Actions

Shares
Downloads
5
Comments
0
Likes
0

Embeds 0

No embeds

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
    No notes for slide
  • Stale trade: A mutual fund’s price is calculated as the NAV at the end of a trading day, 4pm eastern time. Any orders placed during the trading day will be executed at the close NAV, while any orders placed after 4pm will be executed at the close NAV of next trading day. However, some mutual funds (Bank of America, Bank One, Janus, etc.) have allowed some investors (including hedge funds) to place orders after 4pm but still receive that day’s NAV, allowing them to benefit from the valuable post-4pm information at the expense of other investors. Example: One such incident of illegal late trading by Canary occurred October 16, 2002. On that day, the Dow Jones Industrial Average had fallen by 219 points, while the Nasdaq had fallen by 50 points. After the market closed at 4:00, "IBM announced a stunning earnings surprise, beating expectations by 3 cents a share and signaling a new direction for the market." Canary's traders were able to purchase funds shortly after the announcement at the closing price that reflected the 3% market drop for that day, in other words "stale NAVs," knowing that the market would rise the next day because of IBM's announcement. The following day, the market did indeed bounce back: The Dow went up 238 points, while the Nasdaq went up almost 40 points. "Canary made a killing“. There is, however, no such thing as a free lunch. The killing made by Canary cost the long-term buy-and-hold fund shareholders a pretty penny. Canary would purchase a fund one day when they knew the market would rise and then sell a day or two later, reaping the profits that would have otherwise gone to the funds long-term investors: "The late trader's gain is the long-term investor's loss" (Brown, 6).
  • Example of Front-running trade?
  • Anecdote evidence on the loss of managerial talent to hedge fund industry. No formal study so far but on our research agenda. Construct a data set consisting of mutual fund managers that later switched to hedge fund industry to study: Who are likely to switch? (selection issue) What are the behavior changes after the switch, eg, effort exertion and risk taking? (incentive issue) How do they perform relative to hedge fund managers with other backgrounds?
  • So far we have completed the first bullet point and the first part of the 2 nd bullet point.
  • Matching managers’ names turns out to be a very labor intensive work. In case of common names, we check Morningstar and fund web site to make sure that the matched names are indeed referring to the same person.
  • The number of funds that started side-by-side management during the period from 1996 to 2002 accounts for about 70% of all side-by-side funds.
  • Growth oriented US equity funds account for about 60% of all side-by-side funds.
  • Growth oriented US equity funds account for about 60% of all side-by-side funds.
  • Note: each side-by-side fund may have different side-by-side management period.
  • Average across managers: For each side-by-side manager, we first compute the equally weighted average of performance differences for all side-by-side funds under her management. Then, we average across all side-by-side managers (total 97).
  • Superior managerial ability may mitigate the welfare losses due to the conflicts of interest in the side-by-side relationship. To detect the exact welfare loss due to side-by-side arrangement, we need to develop a test controlling managerial ability.
  • The pooled regression controls for time fixed-effect and style fixed-effect. The standard errors are adjusted for hetereoskedasticity and clustered by month. The reported coefficient estimates are actual coefficient multiplied by 100.
  • Average across managers: For each side-by-side manager, we first compute the equally weighted average of performance differences for all side-by-side funds under her management. Then, we average across all side-by-side managers (total 97).

Transcript

  • 1. Side-by-Side Management of Hedge Funds and Mutual Funds Tom Nohel, Loyola University Z. Jay Wang, University of Illinois Lu Zheng, University of California at Irvine
  • 2. Introduction
    • In recent years the “mutual fund scandal” has been much in the news
    • The focus has been on stale trades, lack of independent directors of mutual funds, and conflicts of interest in general
    • At the same time, the scrutiny leveled on the mutual fund industry is starting to shine a spotlight on the hedge fund industry, especially given the tremendous growth in hedge fund assets
  • 3. Policy Concerns
    • Among the concerns of the SEC and legislators in Washington is the practice of having the same individual(s) manage a mutual fund and a hedge fund --- side-by-side management
      • Wellington manages the $18 billion Vanguard Healthcare fund and offers a healthcare hedge fund managed by the same person (Edward P. Owens)
    • Several well-known mutual fund companies have such arrangements
      • e.g., Alliance Capital, Invesco, American Express
    • Others forbid the practice due to fears of conflicts of interest
      • Fidelity
  • 4. Potential Conflicts in Side-by-Side Arrangement
    • Differing compensation structures between mutual funds and hedge funds create potential conflicts:
      • Mutual fund managers: ~1% of assets
      • Hedge fund managers: 1-2% of assets + a performance fee (typically ~20% of profits)
    • Thus manager has an incentive to benefit his hedge fund at the expense of mutual fund investors
  • 5. Manifestation of the Conflicts
    • Front-running hedge fund trades ahead of mutual fund trades
    • Allocating underpriced IPO shares disproportionately to hedge funds
    • Stale trades/Timing of mutual fund shares
      • It is often hedge funds that benefited
  • 6. Policy Debate
    • Due to the potential conflicts of interest inherent in this arrangement some argue to ban the side-by-side arrangements
    • Fund companies that allow this practice argue that without the lure of the possibility to run a hedge fund the best managers will leave
      • The last several years has seen an exodus of managerial talent from the mutual fund industry in search of more money & freedom
  • 7. Our Attempt to Inform This Debate
    • Document the status and evolution of side-by-side arrangement
    • Analyze the welfare consequences of side-by-side arrangement
      • Test for abnormal performance on mutual fund side
      • Test for abnormal performance on hedge fund side
    • Identify the factors that affect management companies’ decision to implement side-by-side arrangement
  • 8. Data & Summary Statistics
    • Data sources:
      • CRSP Mutual Fund Database
      • TASS Hedge Fund Database from Tremont
    • Construct a unique data set of side-by-side funds by matching the managers’ names from the two databases.
      • A total of 112 side-by-side managers who manage 304 mutual funds and 207 hedge funds simultaneously.
      • This covers the period 1990-2005
  • 9. Number of Side-by-Side Funds and Managers 1 1 --- Min 1 1 --- 25% Quantile 2 3 --- 75% Quantile 9 14 --- Max 1 2 --- Median 1.85 2.71 --- Mean 207 304 112 Total Hedge Funds Mutual Funds Managers
  • 10. Time Trend of Side-by-Side Management (When the SBS arrangement began) 5 10 2004 7 25 2003 15 47 2002 17 36 2001 14 44 2000 6 21 1999 6 18 1998 10 27 1997 8 20 1996 7 11 1995 6 11 1994 3 12 1993 3 5 1992 1 5 1991 0 3 1990 Number of Fund Managers Number of Mutual Funds Year
  • 11. Side-By-Side Management by Investment Objectives: Mutual Funds 14 20 Equity USA Growth & Income (GRI) 15 21 Equity USA Aggressive Growth (AGG) 20 25 Equity USA Midcaps (GMC) 29 48 Equity USA Small Companies (SCG) 35 58 Equity USA Growth (GRO) Number of Fund Managers Number of Mutual Funds Investment Objectives
  • 12. Side-By-Side Management by Investment Objectives: Hedge Funds 4 10 Emerging Market 4 11 Fund of Funds 9 13 Equity Market Neutral 9 15 Event Driven (Merger Arb) 71 116 Long/Short Number of Fund Managers Number of Hedge Funds Investment Objectives
  • 13. Summary Stat for Side-by-Side Mutual Funds 0.49 0.00 0.15 0.00 1.20 Min 1.28 28.00 0.75 0.00 37.00 25% Quantile 1.90 140.00 1.00 4.38 580.00 75% Quantile 4.40 720.00 2.25 7.62 14,000.00 Max 1.52 64.57 0.97 2.00 135.60 Median 1.68 106.83 0.94 2.29 793.12 Mean Expenses (%) Turnover (%) Mgmt Fee (%) Total Load (%) TNA ($Mil)
  • 14. Summary Stat for Side-by-Side Hedge Funds 0.00 0.00 0.00 0.00 0.55 Min 0.00 0.00 1.00 20.00 15.53 25% Quantile 6.00 102.50 1.50 20.00 143.15 75% Quantile 36.00 888.00 2.00 20.00 2549.21 Max 0.00 0.00 1.00 20.00 54.73 Median 3.35 57.98 1.17 17.61 158.51 Mean Lock-up (months) Leverage (%) Mgmt Fee (%) Incentive Fee (%) TNA ($Mil)
  • 15. Summary Stat by Investment Objectives: Mutual Funds 0.54 1.03 58.54 2120.51 All 0.76 1.64 56.30 1293.37 Side-by-Side GRI 0.90 1.91 267.77 774.05 All 1.17 2.44 208.24 266.91 Side-by-Side AGG 0.75 1.52 121.52 743.28 All 0.88 1.70 159.70 137.03 Side-by-Side GMC 0.84 1.43 98.47 698.12 All 0.99 1.63 80.60 719.09 Side-by-Side SCG 0.73 1.33 83.80 1228.13 All 0.93 1.51 57.56 1183.24 Side-by-Side GRO Mean Mean Mean Mean Mgmt Fee (%) Expenses (%) Turnover (%) TNA ($Mil) Objective
  • 16. Summary Stat by Investment Objectives: Hedge Funds 26.51 17.58 1.53 190.09 All Markets 0.00 13.50 1.62 386.38 Side-by-Side Emerg. 24.03 9.15 1.44 351.77 All Funds 0.00 3.64 1.60 108.69 Side-by-Side Fund of 75.06 19.53 1.38 199.10 All Neutral 53.09 20.00 1.12 122.64 Side-by-Side Market 55.24 18.83 1.37 481.20 All Driven 73.96 18.73 1.21 62.61 Side-by-Side Event 39.64 19.12 1.29 271.10 All Short 42.40 18.75 1.09 154.75 Side-by-Side Long Mean Mean Mean Mean Leverage (%) Incentive Fee (%) Mgmt Fee (%) TNA ($Mil) Objective
  • 17. Summarizing …
    • Side-by-side management experienced some rapid growth in the late 1990s and early 2000s, and slowed down after 2002
      • $123 billion under management as of 2004 (in mutual funds)
    • Most side-by-side mutual funds are growth oriented US equity funds
    • Side-by-side funds have significantly higher expense ratios and management fees than their peers
    • Side-by-side hedge funds look like their peers, though in general smaller
  • 18. Performance Tests: Side-by-Side Funds vs. Peer Funds (Mutual Funds)
    • Side-by-Side Funds:
      • Sharpe ratios and 4-factor alphas are estimated over the entire side-by-side period based on monthly observations (a period of no less than two years).
      • 235 Mutual funds have enough data to be included
    • Peer Funds:
      • Average Sharpe Ratios and 4-factor α ’s during the side-by-side period are estimated for funds with the same investment objective but w/o side-by-side arrangement.
  • 19. Side-by-Side Funds vs. Peer Funds 0.045%* (0.06) 0.076%** (0.04) 0.033*** (0.00) 0.026*** (0.00) Performance Difference (average across managers) 0.080%*** (0.00) 0.132%*** (0.00) 0.040*** (0.00) 0.032*** (0.00) Performance Difference (Average across funds) -0.085%*** (0.00) -0.087%*** (0.00) 0.103*** (0.00) 0.108*** (0.00) Funds with Same Investment Objectives 0.033% (0.31) 0.044% (0.22) 0.155*** (0.00) 0.139*** (0.00) Side-by-Side Funds Median Mean Median Mean 4-Factor Alpha Sharpe Ratio
  • 20. Portfolio Approach 0.008 (0.45) 0.070*** (0.00) 0.113*** (0.00) 0.073*** (0.00) 0.148*** (0.00) Difference 0.016* (0.06) 0.074*** (0.00) 0.084*** (0.00) 0.710*** (0.00) -0.077* (0.08) No side-by-side 0.024* (0.10) 0.144*** (0.00) 0.197*** (0.00) 0.783*** (0.00) 0.072 (0.32) Side-by-Side MOM HML SMB Market Alpha
  • 21. Summary and Interpretation
    • Side-by-side funds significantly outperform peer funds
      • A bit over 1.5% in 4-factor alpha on an annual basis.
      • Applied to the $123 billion under management in 2004, this translates to ~$2 billion!
    • The superior performance of side-by-side funds is consistent with the existence of a selection bias
      • Side-by-side arrangement is rewarded to better skilled managers for superior performance
    • However, this does not preclude the existence of conflicts of interest
  • 22. Does The Side-by-Side Relationship Curtail Performance?
    • We run a pooled regression with four factor alpha as the dependent variable that allows us to control for fund size, family size, expenses, turnover, and fixed effects for style and time
    • We also include a side-by-side dummy and a pre SBS dummy
    • These dummies allow us to compare the performance of our side-by-side managers before the SBS relationship and while the SBS relationship was in place
  • 23. Performance of Side-by-Side Funds: Regression Approach 385,136 519,872 Observations Included Included Style fixed-effect Included Included Time fixed-effect -9.382*** (0.00) -8.892*** (0.00) Expenses (t-12) -0.018 (0.46) -0.016 (0.47) Log Fund Age (t-12) 0.006 (0.36) 0.004 (0.52) Log Family TNA (t-1) -0.010 (0.55) -0.002 (0.87) Log Fund TNA (t-1) 0.106*** (0.00) 0.125*** (0.00) Pre-Side-by-side Indicator 0.154*** (0.00) 0.136*** (0.00) Side-by-side Indicator Equity Funds All Funds Four-Factor Adjusted Return (t)
  • 24. Does The Side-by-Side Relationship Curtail Performance? NO!
    • Our SBS managers appear to be star performers prior to the SBS relationship
    • Moreover, if anything, their performance is even better once the SBS relationship is in place
    • These results support the industry explanation that SBS privileges are granted to the best managers for purposes of retention
  • 25. Hedge Fund Performance
    • We test for abnormal performance on the hedge fund side
    • Similar to Mutual Fund tests except that we use 6-factor alpha to account for left tail risk in hedge funds
    • Conflicts of interest should lead to superior performance on the hedge fund side
    • Concern over selection bias in hedge fund data
      • Hedge fund data is reported voluntarily, implying that managers with poor track records may not want to report performance
  • 26. Performance of Hedge Funds with Side-by-Side Arrangements -0.059 (0.27) -0.159 (0.28) -0.054*** (0.00) -0.053*** (0.00) Performance Difference (Average across managers) -0.106% (0.13) -0.085% (0.50) -0.060*** (0.00) -0.054*** (0.00) Performance Difference (Average across funds) 0.330%*** (0.00) 0.306%*** (0.00) 0.204*** (0.00) 0.236*** (0.00) Funds with Same Investment Objectives 0.167%** (0.02) 0.222*% (0.08) 0.174*** (0.00) 0.182*** (0.00) Side-by-Side Funds Median Mean Median Mean 6-Factor Alpha Sharpe Ratio
  • 27. Portfolio Approach (6-factor alpha) 0.030** (0.03) 0.087*** (0.00) 0.052** (0.02) 0.191*** (0.00) -0.12 (0.23) Difference 0.076*** (0.00) 0.069** (0.04) 0.080*** (0.00) 0.295*** (0.00) 0.352*** (0.00) No side-by-side 0.106*** (0.00) 0.157*** (0.00) 0.132*** (0.00) 0.486*** (0.00) 0.232 (0.12) Side-by-Side MOM HML SMB Market Alpha
  • 28. Summary
    • Side-by-side mutual funds significantly outperform their peer funds
      • Consistent with self selection: Better ability managers are managing side-by-side funds.
    • Pooled regression shows evidence consistent with high ability managers continuing to outperform their peers
    • On the hedge fund side, side-by-side managers are at best on par with peers, further weakening the case for presence of conflicts of interest
    • Despite potential conflicts of interest in side-by-side relationship, no evidence so far suggesting a significant loss in investor welfare
  • 29. Robustness
    • We eliminate all funds from the peer group that CRSP lists as “team managed” because these have been shown to under-perform: The results are unchanged
    • We distinguish between cases where the SBS-managed mutual and hedge funds are under the same parent company and cases where mutual and hedge funds are under separate parents: SBS funds outperform across the board, but strongest when under same parent
    • We also run our tests in terms of “return gaps”, and again the results are similar
  • 30. Limitations and Future Research
    • Incomplete identification of side-by-side funds
      • Only used one hedge fund data base: TASS
      • Will include two more: HFR & Morgan Stanley
    • Factors affecting the establishment of side-by-side arrangement (Retention?)
    • Impact of side-by-side arrangement on the exit rate of mutual fund managers