SAGE WELCOMES
SAGE WELCOMES John Griffin, Ph.D., University of Texas at Austin Dr. John Griffin is currently a professor of finance at the University of Texas at Austin. Following a Ph.D. in Finance from Ohio State University in 1997, he was an assistant professor at Arizona State University and a visiting associate professor at the Yale School of Management. Dr. Griffin’s research has focused on understanding the nature and accuracy of stock market pricing. In terms of the typical distinctions in finance, his research has two main veins: international stock market pricing and investor behavior in the stock market. He has examined the importance of pricing models, industry factors, exchange rates, price bubbles, agency conflicts, and aspects of individual and institutional investor behavior in stock market pricing, both domestically and internationally. Some of his recent work explores international stock market efficiency and domestic and international implications from the recent financial crisis.
Do Hedge Funds Create Value for Their Clients?
John M. Griffin University of Texas at Austin
The hedge fund industry is experiencing rapid growth Assets Under Management and the Number of Hedge Funds (Source: Hedge Fund Research) 10096 9462 9284 9400
10000
2500
9174
Number of Funds
8661
2000
7436
8000 6297 6000
1500
5379 4454
4000
2000
610 821
1105
1514
1945
2383
2781 2990
3325
3617
1000
3873
500
0
0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
AUM in Billions
Number of Funds
AUM in Billions
12000
What explains the growth of hedge funds?
The conventional wisdom is: 1. Hedge funds generate alpha Hedge fund managers are the smartest! 2. Hedge funds hedge! They provide non-systematic returns
Hedge funds are less constrained and can invest in a variety of assets
3
Do hedge funds generate enough alpha to cover their fees? Industry: Yes, of course. Otherwise they would not be so popular. Academic Literature: Yes. As summarized by Stulz (2007, JEP)
The majority view: Brown, Goetzmann, and Ibbotson (1999), Fung and Hsieh (1997), Ackermann, McEnally, and Ravenscraft (1999), Agarwal and Naik (2000), Ibbotson and Chen (2006); Kosowski, Naik, and Teo (2006), and others…
Probably not for Fund-of-funds: Fung et al. (2008) No!
The minority View: Asness, Krail, and Liew (2001); Amin and Kat (2003); Kat and Palaro (2006), and Griffin and Xu (2009)
4
Potential problems with measuring performance Reported return data can suffer from survivorship bias Hedge funds use a variety of strategies Changing exposures Options, Leverage Can a factor model capture this?
Returns are often smoothed by the nature of reporting illiquid assets Can
a factor model capture this?
Sometimes purposefully smoothed!
(Daniel, Agarwal, and Naik (2011, RFS).
Measuring hedge fund factor exposures will be noisy Performance will be sensitive to the factors and method chosen
5
What do all these problems mean? They affect beta measurement but not alpha Alpha is biased upward Alpha is biased downward
6
If these biases affect all reported return studies what can be done? Examine Stock Holdings 32% of AUM 42% of Funds
Fung and Hsieh (2006)
Advantage of approach: Holdings have none of the problems listed on the previous slides.
Examine the patterns across the business cycle Advantage of approach: Not restricted just to equity strategies Can see if alpha is mismeasured
Mandatory 13F filings.
Limitations of approach: Equities only Long only Quarterly positions, No high frequency trades
Results from Griffin and Xu (2009, RFS)
Results from Griffin and Tiu, 8 work in progress
Holding Data 306 hedge fund firms Each firm can represent several or many funds
Performance 1986-1994 Pre-sample period sources to avoid survivor bias No Backfill: Only includes funds the year after first being reported in any of the databases
9
Preview of Griffin and Xu Ability Hedge fund holdings and changes in holdings don’t predict stock returns Stock picking
Limited to 1999-2000, if control for type of High P/S stocks then no outperformance Very unlikely to cover the higher hedge fund fee structure
Sector timers, average style
No evidence of ability If hedge funds can’t time growth, value, or momentum, why will they be any better at stock/bond markets?
Performance persistence The economic magnitudes and statistical significance are weak. The best stock pickers do seem to have some stock picking ability but they aren’t good timers 10
Performance Measure for holdings Holding-based DGTW (1997) Performance Measure Stock picking: Characteristic Selectivity (CS)—average return relative to the benchmark Timing ability: Characteristic Timing (CT)—did the weights on momentum change in the year prior to momentum strategies doing well? Average Style (AS)—how did the average style do?
12
Equal-Weighted DGTW Performance Stock picking? (Characteristic Selectivity) 20
15
10 Hedge Funds Mutual Funds 5
0
-5 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
13
Equal-Weighted DGTW Performance Timing ability? (Characteristic Timing) 5 4 3 2 1 Hedge Funds
0
Mutual Funds
-1 -2 -3 -4 -5 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
14
Performance Summary Stock picking Stock Picking T-statistic
Hedge Funds
Mutual Funds
Difference
2.15
0.82
1.32
-2.22
-1.94
-1.98
Hedge Funds
Mutual Funds
Difference
0.24
0.43
-0.19
-0.50
-1.00
-.84
Timing Timing
T-statistic
Economically weak evidence of stock picking (1.32 percent extra return per year) No evidence of timing ability 15
Did the hedge funds earn their fees? Did the hedge fund managers outperforming the mutual fund managers by 1.32 percent per year, earn their fees?
16
But… that is the average fund! “Most people can‟t do it but, we pick the good managers.” And investors are saying In 2008, who knew that that one of his funds is this man… down 30 percent for 2011. Is this antidotal evidence or a pattern?
would top all his peers and earn 4.9 Billion in 2010?
17
Are some hedge funds better than others? Stock Picking Distribution 35 Hedge Fund Mutual Fund
25 20 15 10 5
0.27
0.23
0.19
0.15
0.11
0.07
0.03
0.01
0.05
0.09
0.13
0.17
0.21
0
0.25
Percent of Funds
30
Characteristic Selectivity 19
Are some hedge funds better than others?
50 45 40 35 30 25 20 15 10 5 0
0.27
0.23
0.19
0.15
0.11
0.07
0.03
0.01
0.05
0.09
0.13
0.17
0.21
Hedge Fund Mutual Fund
0.25
Percent of Funds
Characteristic Timing Distribution
Characteristic Timing 20
Are some hedge funds better than others? Portfolio quintiles ranked by prior year gross returns / performance
21
Coming back to the common views... 1. Hedge funds generate alpha Hedge fund managers are the smartest! Not true when performance can be measured well in equities 2. Hedge funds hedge! They provide non-systematic returns Is this true?
22
How would one know if alpha was actually „Hidden Beta‟? Alpha is by definition non-systematic risk It is what is left over after removing all the systematic risk components. Hence, hedge fund alphas should be unrelated to market conditions Alpha should not be systematically negative in a time of crisis If this is not true then alpha is not really alpha Alpha would actually be „Hidden Beta‟ risk
23
Summary Recall the conventional view is: 1. Hedge funds generate alpha 2. Hedge funds hedge! What is wrong with this view:
24
Do Hedge Funds Create Value for Their Clients?
John M. Griffin University of Texas at Austin
The hedge fund industry is experiencing rapid growth Assets Under Management and the Number of Hedge Funds (Source: Hedge Fund Research) 10096 9462 9284 9400
10000
2500
9174
Number of Funds
8661
2000
7436
8000 6297 6000
1500
5379 4454
4000
2000
610 821
1105
1514
1945
2383
2781 2990
3325
3617
1000
3873
500
0
0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
AUM in Billions
Number of Funds
AUM in Billions
12000
What explains the growth of hedge funds?
The conventional wisdom is: 1. Hedge funds generate alpha Hedge fund managers are the smartest! 2. Hedge funds hedge! They provide non-systematic returns
Hedge funds are less constrained and can invest in a variety of assets
3
Do hedge funds generate enough alpha to cover their fees? Industry: Yes, of course. Otherwise they would not be so popular. Academic Literature: Yes. As summarized by Stulz (2007, JEP)
The majority view: Brown, Goetzmann, and Ibbotson (1999), Fung and Hsieh (1997), Ackermann, McEnally, and Ravenscraft (1999), Agarwal and Naik (2000), Ibbotson and Chen (2006); Kosowski, Naik, and Teo (2006), and others…
Probably not for Fund-of-funds: Fung et al. (2008) No!
The minority View: Asness, Krail, and Liew (2001); Amin and Kat (2003); Kat and Palaro (2006), and Griffin and Xu (2009)
4
Potential problems with measuring performance Reported return data can suffer from survivorship bias Hedge funds use a variety of strategies Changing exposures Options, Leverage Can a factor model capture this?
Returns are often smoothed by the nature of reporting illiquid assets Can
a factor model capture this?
Sometimes purposefully smoothed!
(Daniel, Agarwal, and Naik (2011, RFS).
Measuring hedge fund factor exposures will be noisy Performance will be sensitive to the factors and method chosen
5
What do all these problems mean? They affect beta measurement but not alpha Alpha is biased upward Alpha is biased downward
6
If these biases affect all reported return studies what can be done? Examine Stock Holdings 32% of AUM 42% of Funds
Fung and Hsieh (2006)
Advantage of approach: Holdings have none of the problems listed on the previous slides.
Examine the patterns across the business cycle Advantage of approach: Not restricted just to equity strategies Can see if alpha is mismeasured
Mandatory 13F filings.
Limitations of approach: Equities only Long only Quarterly positions, No high frequency trades
Results from Griffin and Xu (2009, RFS)
Results from Griffin and Tiu, 8 work in progress
Holding Data 306 hedge fund firms Each firm can represent several or many funds
Performance 1986-1994 Pre-sample period sources to avoid survivor bias No Backfill: Only includes funds the year after first being reported in any of the databases
9
Preview of Griffin and Xu Ability Hedge fund holdings and changes in holdings don’t predict stock returns Stock picking
Limited to 1999-2000, if control for type of High P/S stocks then no outperformance Very unlikely to cover the higher hedge fund fee structure
Sector timers, average style
No evidence of ability If hedge funds can’t time growth, value, or momentum, why will they be any better at stock/bond markets?
Performance persistence The economic magnitudes and statistical significance are weak. The best stock pickers do seem to have some stock picking ability but they aren’t good timers 10
Performance Measure for holdings Holding-based DGTW (1997) Performance Measure Stock picking: Characteristic Selectivity (CS)—average return relative to the benchmark Timing ability: Characteristic Timing (CT)—did the weights on momentum change in the year prior to momentum strategies doing well? Average Style (AS)—how did the average style do?
12
Equal-Weighted DGTW Performance Stock picking? (Characteristic Selectivity) 20
15
10 Hedge Funds Mutual Funds 5
0
-5 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
13
Equal-Weighted DGTW Performance Timing ability? (Characteristic Timing) 5 4 3 2 1 Hedge Funds
0
Mutual Funds
-1 -2 -3 -4 -5 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
14
Performance Summary Stock picking Stock Picking T-statistic
Hedge Funds
Mutual Funds
Difference
2.15
0.82
1.32
-2.22
-1.94
-1.98
Hedge Funds
Mutual Funds
Difference
0.24
0.43
-0.19
-0.50
-1.00
-.84
Timing Timing
T-statistic
Economically weak evidence of stock picking (1.32 percent extra return per year) No evidence of timing ability 15
Did the hedge funds earn their fees? Did the hedge fund managers outperforming the mutual fund managers by 1.32 percent per year, earn their fees?
16
But… that is the average fund! “Most people can‟t do it but, we pick the good managers.” And investors are saying In 2008, who knew that that one of his funds is this man… down 30 percent for 2011. Is this antidotal evidence or a pattern?
would top all his peers and earn 4.9 Billion in 2010?
17
Are some hedge funds better than others? Stock Picking Distribution 35 Hedge Fund Mutual Fund
25 20 15 10 5
0.27
0.23
0.19
0.15
0.11
0.07
0.03
0.01
0.05
0.09
0.13
0.17
0.21
0
0.25
Percent of Funds
30
Characteristic Selectivity 19
Are some hedge funds better than others?
50 45 40 35 30 25 20 15 10 5 0
0.27
0.23
0.19
0.15
0.11
0.07
0.03
0.01
0.05
0.09
0.13
0.17
0.21
Hedge Fund Mutual Fund
0.25
Percent of Funds
Characteristic Timing Distribution
Characteristic Timing 20
Are some hedge funds better than others? Portfolio quintiles ranked by prior year gross returns / performance
21
Coming back to the common views... 1. Hedge funds generate alpha Hedge fund managers are the smartest! Not true when performance can be measured well in equities 2. Hedge funds hedge! They provide non-systematic returns Is this true?
22
How would one know if alpha was actually „Hidden Beta‟? Alpha is by definition non-systematic risk It is what is left over after removing all the systematic risk components. Hence, hedge fund alphas should be unrelated to market conditions Alpha should not be systematically negative in a time of crisis If this is not true then alpha is not really alpha Alpha would actually be „Hidden Beta‟ risk
23
Summary Recall the conventional view is: 1. Hedge funds generate alpha 2. Hedge funds hedge! What is wrong with this view:
24
