Hedge Funds Q Group October 19, 2011 Institutional Quality Hedge Funds David A Hsieh (c) David A. Hsieh, 2011 Do not quote without written permission. Outline � Increase presence of institutional investors in hedge funds since 2001. � Investment experience?? � Need: “Market portfolio” ~ CRSP VW index � Problem: Incomplete AUM in public database � Solution: Add large firms in private database � Benefit: “Institutional quality” firms ~ S&P500 � Observations on firm size v performance (c) David A. Hsieh 2011. Do not distribute or quote. 2
Hedge Funds Institutional Investors Are Increasing Allocation to Hedge Funds Allocation to Hedge Funds (% of Assets) 25% University Endowments Defined Benefit Pensions 20% 15% 10% 5% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 3 Investment Experience ? � Q: What is the investment experience of the average dollar invested in hedge funds? � A: Need the “market portfolio” of hedge funds, an asset-weighted return ~ CRSP VW index � But hedge funds are private investment vehicles. � AUM of the industry is incomplete. � Need a proxy ~ S&P 500 index (c) David A. Hsieh 2011. Do not distribute or quote. 4
Hedge Funds I. Sample Construction � Start with Public Databases (3). Add from public sources identities of mega hedge fund firms (2) and their AUM data; collect missing return data from private sources � Public database (PD): � Merge reporting firms in Barclays Hedge, HFR and Lipper/TASS � Verify AUM against II 100, AR BDC where possible. � Sort by AUM, and divide into deciles (D01-D10). � Add names and AUM of non-reporting large firms in surveys: II 100 and AR BDC. � Find funds and returns of non-reporting large firms in private database. (c) David A. Hsieh 2011. Do not distribute or quote. 5 5 Public Data Set: Reporting Firms/Funds: Year End 2010 Source: # of Firms # of Funds AUM ($b) Barclays 1,314 3,226 $552 HFR 1,805 4,737 $713 Lipper/TASS 1,412 4,122 $717 Merge 2,442 6,606 $1,322 (c) David A. Hsieh 2011. Do not distribute or quote. 6 6
Hedge Funds Non-reporting/Private Data Set Mega Firms/Funds: Year End 2010 Source # of Firms AUM ($b) Reporting firms (public) 2,442 1,322 II 100 firm added 54 592 (out of 100) (out of $1,231) AR BDC firms added 112 284 (out of 330) (out of $1,701) Total $2,608 $2,199 Non-reporting/Reporting 7% 66% HFN Administrator Survey $2,826 (AUA) (c) David A. Hsieh 2011. Do not distribute or quote. 7 7 Total Number of Firms at Year End 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 8 8
Hedge Funds Total AUM at Year End of 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 9 9 Firm Size Comparison: 2001-2010 7,000 Smallest II 100 6,000 Smallest AR BDC 5,000 Smallest D10 AUM ($m) 4,000 Median 3,000 2,000 1,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 10
Hedge Funds Dominance of Mega Firms: 2001-2010 AUM by Decile and Year ($ billion) 3,500 Missing (HFN survey) 3,000 D10 (non-reporting) 2,500 D10 (reporting) D01-D09 2,000 1,500 1,000 500 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 11 11 AUM Concentration: Percent of AUM in Mega Firms (Total Sample) 151 164 227 252 309 331 369 358 355 451 1026 1132 1269 1421 1650 1761 2049 2140 2185 2443 (c) David A. Hsieh 2011. Do not distribute or quote. 12 12
Hedge Funds Firm Survival Probabilities, by AUM Decile 1.0 D10 D09 0.8 D08 D07 0.6 D06 0.4 D05 D04 0.2 D03 D02 0.0 D01 1 2 3 4 5 6 7 8 9 Years since decile formation (c) David A. Hsieh 2011. Do not distribute or quote. 13 Annual Entry and Exit Rates, by AUM Decile 0.6 Entry Exit 0.5 0.4 0.3 0.2 0.1 0 D01 D02 D03 D04 D05 D06 D07 D08 D09 D10 (c) David A. Hsieh 2011. Do not distribute or quote. 14
Hedge Funds Annual Transition Rates, by AUM Decile 0.9 0.8 Down 1 Stay Up 1 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 D01 D02 D03 D04 D05 D06 D07 D08 D09 D10 (c) David A. Hsieh 2011. Do not distribute or quote. 15 Qualitative Characteristics � Large firms manage >80% of AUM. � Large firms survive longer. � Large firms tend to stay large. � Large firms have less entry and less exit. � Institutional investors prefer large firms. Possible reasons: cost, career concerns, etc. (c) David A. Hsieh 2011. Do not distribute or quote. 16
Hedge Funds Firm as the Unit of Analysis � We propose to study firms, rather than funds, for two reasons. � Demand side: institutional investors look at firms and strategies, not single funds. � Supply side: if Berk and Green (2004) applies to funds, one way to increase firm size is to add funds, typically with different styles. � Information: 13/F, II 100, AR BDC @ firm level. (c) David A. Hsieh 2011. Do not distribute or quote. 17 II. Performance in Firms with AUM >$50m � Small firms are hard to follow, due to high entry and exit rates. � Small firms’ data are hard to verify. � Indexers have imposed size cut offs. � We do the same here. Start AUM at $50m. � Sort firms in PD by deciles: E01, E02, …, E10 � Add non-reporting II 100 and AR BDC firms. (c) David A. Hsieh 2011. Do not distribute or quote. 18
Hedge Funds Annual Excess Returns by AUM Decile 7% 6% 5% 4% 3% 2% Mean+1s Mean Mean-1s 1% 0% E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100_R II100_NR II100 (c) David A. Hsieh 2011. Do not distribute or quote. 19 Sharpe Ratio by AUM Decile 1.20 1.00 0.80 0.60 0.40 0.20 0.00 E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100_R II100_NR II100 (c) David A. Hsieh 2011. Do not distribute or quote. 20
Hedge Funds Major Risk Exposures of Hedge Funds � Equity risk: S&P500 Russell 2000 – S&P500 Emerging market equity � Bond risk: 10 year treasury Moody’s Baa – 10 year treasury � Volatility: Straddles on FX, 3m rates, bonds � These are meant to capture common exposures in the industry. (c) David A. Hsieh 2011. Do not distribute or quote. 21 Russell 2000-S&P 500 Exposure 0.25 Beta(RL-SP)+1s Beta(RL-SP) Beta(RL-SP)-1s 0.15 0.05 -0.05 -0.15 -0.25 -0.35 E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100 II100_R II100_NR (c) David A. Hsieh 2011. Do not distribute or quote. 22
Hedge Funds Credit Spread Exposure 0.35 Beta(Baa-TY)+1s Beta(Baa-TY) Beta(Baa-TY)-1s 0.30 0.25 0.20 0.15 0.10 0.05 0.00 E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100 II100_R II100_NR (c) David A. Hsieh 2011. Do not distribute or quote. 23 Emerging Market Equity Exposure 0.25 0.20 0.15 0.10 Beta(IFC-Rf)+1s Beta(IFC-Rf) Beta(IFC-Rf)-1s 0.05 0.00 E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100 II100_R II100_NR (c) David A. Hsieh 2011. Do not distribute or quote. 24
Hedge Funds Monthly Alpha vs 8 Risk Factors 0.40% Alpha+1s Alpha Alpha-1s 0.30% 0.20% 0.10% 0.00% -0.10% -0.20% -0.30% E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100 II100_R II100_NR (c) David A. Hsieh 2011. Do not distribute or quote. 25 Bull vs Bear Market Exposure 0.25 Beta(RL-SP)-Bull Beta(RL-SP) Beta(RL-SP)-Bear 0.15 0.05 -0.05 -0.15 -0.25 -0.35 E01 E02 E03 E04 E05 E06 E07 E08 E09 E10 II100 II100_R II100_NR (c) David A. Hsieh 2011. Do not distribute or quote. 26
Hedge Funds Return Comparison Across AUM Deciles � Excess return, Sharpe ratio, and alpha: U-shaped pattern across deciles. � Large firms have less equity exposure. � Large firms have more credit spread exposure. � All firms have strong emerging market exposure. � Equity risk is lower in bear market. � Implication: equal weighting across funds puts most of the weight on small firms. (c) David A. Hsieh 2011. Do not distribute or quote. 27 III. Delisting Bias of Firms >$50m AUM � Debate on delisting bias: funds stop reporting due to bad returns vs good returns � From private sources: 1,373 funds (share classes) have 15,371 monthly returns after delisting from public databases. 410 are still alive. � Worst: -100%. Best: 84.15%. Average: 0.27% � Delisting bias is negligible!!! (c) David A. Hsieh 2011. Do not distribute or quote. 28
Hedge Funds IV. Institutional Quality Firms: The “S&P500” Analog � Institutional Quality (“IQ”) firms = all firms with AUM higher than the E09-E10 cutoff. � In numbers: 8-10% of all firms (80 – 218 firms) � Manage 60-75% of the AUM. � AUM-weighted return of IQ firms ~ S&P 500. (c) David A. Hsieh 2011. Do not distribute or quote. 29 Number of IQ firms by year 250 Reporting Non-reporting II100 Non-reporting ARBDC 200 150 100 50 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 (c) David A. Hsieh 2011. Do not distribute or quote. 30
Hedge Funds IQ firms as percent of all firms 100% 80% 60% 40% By AUM By # of firms 20% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (c) David A. Hsieh 2011. Do not distribute or quote. 31 Comparison with Selected Indices 5.4% 0.92 5.3% 0.90 5.2% 0.88 5.1% 0.86 5.0% 0.84 4.9% 0.82 4.8% 0.80 4.7% 0.78 4.6% 0.76 4.5% 0.74 Excess Return (Left scale) 4.4% Sharpe Ratio (Right scale) 0.72 4.3% 0.70 IQ HFRI DJCSI DJCSMS (c) David A. Hsieh 2011. Do not distribute or quote. 32
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