A few weeks ago we wondered if reports of the death of the “hedge fund model” were true or whether hedge funds had just been knocked unconscious for a while. Apparently we weren’t the only ones curious about the hedge fund afterlife. On Halloween, of all days, researchers in the US and Germany (re-)released a study on the average returns of “dead” hedge funds.
“Returns of dead funds?” you ask. Yes indeed. James Hodder, Jens Carsten Jackwerth and Olga Kolokolova have developed a methodology they say allows them to calculate the returns of hedge funds that have stopped reporting to hedge fund databases (often inaccurately referred to as “dead”.)
Based on media reports regarding the number of hedge funds in the world, you might think that any fund that ceases to voluntarily report their returns has simply “blown up“. But the authors of this paper say that only a fifth of funds that stop reporting actually say that it’s because they were liquidating. Five percent say they have simply closed to new investments and 76% don’t say why they have stopped reporting.
So ceasing to report is not the same as closing down the fund. But how can you measure the performance of the non-reporting – yet very much alive – funds? By examining the returns of funds of funds, say the authors. The returns of funds of funds will still incorporate the returns of single manager funds that stop reporting to a major database.
Nifty idea. But the problem is that most funds of funds don’t publicly report their underlying funds. So the authors of this study do the next best thing – they guess the underlying funds based on the performance of the fund of funds itself (using principal component analysis, a form of regression).
The approach is quite complex, but the conclusion is simple enough. According to the paper, the average “de-listed” hedge fund had a monthly return of -1.86% right after it delisted. That’s not so hot compared to the average monthly return for a live fund of 1.01%. So perhaps it comes as no surprise that these funds have decided to stop telling the world about their performance.
The inferred “delisting return” (return from the month the fund was delisted) for funds that were ceasing to accept new investments was over 1%. Not too bad – as you might expect from a fund that has apparently been raising capital so fast, it had to close to new investors.
But oddly, the delisting return for liquidating funds was even better (2.34%). However, as you might guess, the delisting return for funds that gave no reason for ceasing to report was an abysmal -3.27%. While this return certainly stinks, the authors point out that it doesn’t come close to the “blow-up” that is often ascribed to these funds. (Some researchers have apparently assumed the delisting return was -50% in their analyses of hedge fund returns – as if funds that stop reporting had essentially blown up.)
Guessing at the holdings of a fund of funds and then using those weights to make further guesses about the performance of underlying funds may be a pretty rough way to divine their unreported holdings, but if even partly true, this research suggests that voluntary reporting should be taken with a grain of salt. “Dead”, may not actually mean a fund’s assets have gone to the great fund of funds in the sky.