1. Hedge Funds: A Global Perspective on Strategies and Risks
James R. Barth Auburn University and Milken Institute
[email protected] Mark Bertus Auburn University [email protected]
Tong Li Milken Institute cli@milkeninstitute Triphon Phumiwasana
Milken Institute [email protected] Preliminary Draft
Prepared for Joint Meeting of the Shadow Financial Regulatory
Committees of Europe, Japan, Latin America and the United States
Copenhagen, Denmark September 7-8, 2007
2. Introduction Unlike hedge funds, mutual funds are widely
available to the public and therefore must be registered with the
Securities and Exchange Commission. In addition, they are limited
in the strategies they can employ. Hedge funds, on the other hand,
are set up as limited partnerships and generally not constrained by
regulatory limitations on their investment strategies. Indeed,
although the word hedge refers to the hedging of the value of
assets through the use of derivative instruments or the
simultaneous use of long positions and short sales, most hedge
funds do not involve hedging in this traditional sense. Many, in
fact, do just the opposite. In this section, we examine some of the
different strategies to determine differences in performance and
risk. The impact of hedge funds on global financial stability and
the need for greater regulation are important and timely issues,
and it is no surprise that economists have tried to address them.
But the results of these efforts have been less than successful.
For example, in a recent study attempting to quantify the potential
impact of hedge funds on systemic risk, Chan, Getmansky, Haas, and
Lo (2005, p. 97) state that we cannot determine the magnitude of
current systemic risk with any degree of accuracy. Similarly,
Garbaravicius and Dierick (2005, p. 55) conclude, It is very
difficult to provide any conclusive evidence on the impact of hedge
funds on financial markets. ... Timothy Geithner (Geithner, p. 8),
president of the Federal Reserve Bank of New York, gave a lecture
in Hong Kong in September 2006, and addressed the issue of hedge
fund regulation. Clearly, capital supervision and market discipline
remain the key tools for limiting systemic risk, he said. The
emergence of new market participants such as leverage institutions
does not change that. In addition, Danielsson, Taylor, and Zigrand
(2005, pp. 2627) argue that while there exists a need for a
credible resolution mechanism to deal with the default of
systemically important hedge fund(s) the procedural issues and
related incentive effects [to do so] are complex [and] require
further consideration in order to provide the correct incentives
for the various parties. Given the conclusions of these efforts, we
have decided not to try to expand upon this line of enquiry here.
Instead, we provide a comprehensive examination of some important
aspects of the global hedge fund industry. This examination is
based on a dataset assembled by HedgeFund.net that starts with
eight hedge funds with $57 million 2
3. in assets in 1980 and grows to 7,144 funds with $1,232
billion in assets as of May 2007. We use this dataset to examine
differences among hedge funds over time and by the strategies they
employ. We pay particular attention to changes in the performance
and risk of funds over time, and to the impact of various
strategies on these differences. We also use regression analyses to
examine the associations between a funds strategy and its
associations between abnormal market movements. I. An Overview of
the Hedge Fund Industry A. Growth and Size The recent flurry of
news stories about hedge funds might lead some to think that such
funds are relatively new. But Fung and Hsieh (1999) report that the
first hedge fund was actually formed in 1949. It employed a
long/short equity strategy and operated on the basis of leverage,
two characteristics of many hedge funds today. They add that this
first hedge fund remained fairly obscure until a magazine article
in 1966 touted its high returns relative to those of mutual funds.
The number of hedge funds subsequently grew fairly rapidly for a
few years but fell back into obscurity due to losses suffered in
several downturns in the equity market. The industry rebounded once
again in 1986, when another magazine article reported that a newly
established hedge fund had earned an extraordinary return in its
first few months of existence. Today, there is roughly $1.232
trillion of assets under management in Hedge Funds globally (see
Table 1). Moreover, in terms of the regional distribution of these
assets, 51% are managed by Hedge Funds in the United States, while
41% and 8% are managed by Hedge Funds in Europe and the rest of the
world respectively. While the magnitude of capital invested in
hedge funds seems quite large, relative to levels of global GDP,
banking assets, stock market capitalization, bond markets,
derivative markets and Mutual Funds, these funds are minute. More
specifically, assets under management by Hedge Funds are roughly 2,
1.5, 2, 1.7, 1.8 and 5 percent of the size of these other financial
markets respectively. Looking at industry growth, the number of
hedge funds has been increasing exponentially. Tables 2, 3 and 4
(see also Figures 1, 2, and 3) show the dramatic increase in the
numbers, assets, and returns, for the industry for the last
seventeen years. With the 3
4. exception of a decline in the number of funds during the
first six months of 2006, from Jan 1990 to May 2007, Hedge Funds
grew in number at an average annual rate of 26 percent.
Additionally, total assets grew at an average annual rate of 38
percent, while the average monthly returns and standard deviations
have steadily dampened. Not all funds that entered the industry
during this time period remained alive until the ending date, of
course. In fact, as of June 2006, 3,100 funds with $257 billion had
exited the industry. Today, despite these exits, 7,144 funds
remain. B. Differences in Size, Domicile, Location, and Age of
Funds Although there has been growth in both the number and assets
of hedge funds, asset growth has exceeded their growth in number.
As a result, as table 2 shows, the average size of hedge funds has
increased by more than 500 percent from 1990 to May 2007, from $34
million to $172 million. This occurred despite the fact that the
average size of exiting funds is greater than the average size of
entering funds. This difference reflects the fact that the age of
exiting funds is greater than that of the newly entering funds. Not
surprisingly, the average age of a fund has increased since 1980.
As of June 2006, the typical fund had been in existence 5.3 years.
Tables 5 and 6 provide information on the domiciles of hedge funds
and the locations of the funds assets. Table 5 provides this
information based upon the number of funds, while table 6 does the
same for assets. Of the 7,144 funds as of May 2007 49 percent, or
3,528, are domiciled in the United States, and of these about half
have their assets in the United States, with nearly all the
remaining assets invested globally. Europe is second to the United
States in terms of the number of domiciled funds, accounting for
approximately 35 percent, or 2,483, of the total number of funds;
of these only about 19 percent have their assets invested in
Europe. The majority of the funds, 67 percent, have invested their
assets globally. However, 76 percent of the funds with 75 percent
of total fund assets still have their investments in U.S.
dollar-denominated assets, regardless of where the assets are
located. Table 6 also shows that the funds domiciled in the United
States account for the largest amount of assets, $632 billion, with
Europe second at $471 billion. Together they account for slightly
less than 90 percent of the $1,226 billion in total fund assets.
For 4
5. funds domiciled in the United States, 47 percent are
U.S.-allocated and 48 percent are invested globally, while for
Europe 24 percent are allocated within the continent and 63 percent
globally. European-domiciled funds invest more assets in Asia, in
terms of absolute amount and as a share of their total assets, than
do funds domiciled in the United States. C. Hedge Fund Strategies
Hedge fund performance and risk understandably attract the most
investor attention. Tables 2, 3, and 4 show the average monthly
return and volatility, as measured by standard deviation, of hedge
funds from 1990 to May 2007. For all funds the average monthly
returns range from a high of 2.39 percent in 1999 to a low of 0.3
percent in 2002. Separating the hedge funds into traditional and
fund of funds returns the average monthly returns range from a high
of 2.54 and 3.67 percent in 1999 to a low of 0.35 percent in 2002
and -0.16 percent in 1994 respectively. Hedge funds come not only
in a variety of sizes, asset locations, and domiciles, but also in
a variety of strategies. Our dataset lists 36 strategies for hedge
funds and these strategies are defined in table 7. Table 8
illustrates the relative importance of each strategy based on the
share of that strategy in the total number of hedge funds and on
the share of that strategy in the total assets of hedge funds. The
two most common strategies employed are the fund of funds and the
long-short equity, with 24 percent of all funds employing the
former and 21 percent of all funds employing the latter. The funds
employing these two strategies also account for 25 percent and 17
percent of the total assets of funds, respectively. In terms of
concentration, 65 percent of all funds invested 65 percent of all
assets in one of four trading strategies; fund of funds, Long/short
equity, CTA/Managed futures, and Multi-strategy. Over the last
decade the number of funds following these strategies grew at an
average rate of 19 percent and the assets grew by 40 percent.
Moreover, hedge funds in these four trading strategies earned an
average monthly rate of return of 1 percent while experiencing a
volatility level of 1.93 percent. In general, Table 8 shows that
the average growth in all hedge funds and assets across all
strategies for the last ten years was roughly 18 and 38 percent
respectively. 5
6. Hedge funds following the asset based lending strategy
experienced the largest growth in numbers, 40 percent, and assets,
108 percent. In terms of individual performances, hedge funds using
the fixed income arbitrage strategy earned the highest average
return, 2.71 percent, and faced the greatest risk, 10.5 percent. As
of May 2007, funds of funds constitute the largest group of
existing funds, both in terms of number and assets; these are
followed by long/short equity funds. In contrast, long/short equity
funds, event-driven funds, and market-neutral funds make up the
largest groups of graveyard funds. Looking at the total assets and
numbers of entering and exiting hedge funds according to strategy,
funds of funds with multi-strategies account for 25 percent of
total entering funds and 21 percent of entering-funds assets. They
also account for 23 percent of total exiting funds and 26 percent
of exiting-funds assets. Figure 4 shows the risk-return tradeoffs
for hedge funds grouped on the basis of strategy. The figure
indicates a significantly positive relationship on average between
return and risk. Still, some of the strategies employed by funds
have underperformed, in terms of generating a return that
compensates for the associated risk. This is the case for several
strategies when examining the tradeoffs both for the most recent
five-year period and the past year, but especially so in the latter
case. D. Management Fees The management fees of hedge funds attract
a great deal of attention, not only from potential investors but
also from the financial press. Managers of such funds rely on these
fees and performance incentives for their income, above and beyond
the returns they receive on their own investments in the funds.
Currently, funds with only 5 percent of total assets set such fees
at 0.75 percent or less. Funds accounting for 55 percent of total
assets, however, set fees at 1.25 percent or higher. Funds with
just 2 percent of the assets, which are those at the low and high
extremes, set fees at less than 0.25 percent and greater than 2.25
percent, respectively. Over time, the shares of total assets
reflecting different management fees have shifted into the higher
categories, but with substantial variation across the different
ranges of fees. 6
7. There is significant variation in the number of entering and
exiting hedge funds and their asset concentrations, based on
strategy distribution and management fees. Funds with 7 percent of
total assets of entering hedge funds set management fees at 0.75
percent or less. Funds accounting for 89 percent of total assets of
entering funds charge a management fee higher than 0.75 percent,
but no greater than 2.25 percent. Funds that account for 91 percent
of exiting funds have a management fee between 0.75 percent and
2.25 percent. Only 3 percent exiting funds set the management fee
at less than 0.25 percent or higher than 2.25 percent, which are
the low and high extremes for management fees, respectively. The
performance incentives of hedge funds clearly attract the most
attention. The reason is 60 percent of all hedge funds charged
incentives of 15 percent or higher. The hedge funds charging these
fees, moreover, accounted for 56 percent of total assets. We detect
a binomial distribution of incentive fees in the following sense:
Most funds with the most assets either charge less than 10 percent
or between 15 percent and 20 percent. There is roughly a 30 percent
to 50 percent split, in terms of both number and assets, for funds
charging 10 percent or less and those charging between 15 percent
and 20 percent, respectively. The performance incentives, moreover,
have tended to drift upward since the early 1980s, despite the
tremendous increase in the number and assets of hedge funds.
Looking at the numbers of entering and exiting hedge funds and
their asset allocations, based on strategy distribution and
management incentives, fifty-eight percent of all entering funds,
which represent 59 percent of total assets, set the incentive fee
at 15 percent to 20 percent in 2006. That fee range also
corresponds to 64 percent of all exiting funds, which represent 48
percent in assets. Funds that account for 30 percent of total
assets of exiting funds have an incentive fee of less than or equal
to 5 percent. E. Lockup Periods When investors initially put their
money into hedge funds, they cannot freely cash out at any time
thereafter. Instead, they are required to remain in the fund over a
specified period of time before any withdrawals may take place. The
required minimum time period is the initial lockup period. Nearly
50 percent of funds as of June 2006 have a 7
8. lockup period of up to 30 days, with the vast majority of
the remaining funds having a lockup period of up to a year. In
terms of the distribution of assets by entering and exiting hedge
funds, based on lockup periods, the funds representing half the
assets of all entering funds have a lockup period longer than one
quarter, but no longer than one year. However, this group of funds
only represents 30 percent of the assets of exiting funds. Funds
with a lockup period up to 30 days account for 22 percent of the
exiting funds in terms of assets. The distribution of the assets of
funds by lockup period closely parallels that for the number of
funds. 49 percent of the assets of all funds are linked to lockup
periods of up to 30 days. Only 2 percent are linked to lockup
periods exceeding a year. Over time, there has been a shift toward
longer lockup periods employed by more funds with more assets. We
also examine the lockup periods employed by funds of different
sizes and strategies. In general, there is not much of a difference
in lockup periods employed by funds of varying sizes and
strategies. The lockup period is shortest for the commodity trading
adviser funds and longest for the sector funds, with event-driven
funds closely behind. In the case of commodity trading adviser
funds, 91 percent of the assets are in the funds with a lockup
period of 30 days or less; in the case of sector funds, 61 percent
of the assets are in the funds with a lockup period of more than 90
days, but less than a year. Since hedge funds require the services
of both accounting and brokerage firms, it is informative to
examine which firms are most frequently used. Three accounting
firms, PriceWaterhouse Coopers, Ernst & Young, and KPMG, are
the firms of choice for 54 percent of all hedge funds reporting
such information, and that these funds account for 65 percent of
total assets. Nearly 40 percent of the funds with 41 percent of
total assets do not report information about which brokerage firms
are used. Of those that do report this information, Morgan Stanley,
Goldman Sachs, and Bear Stearns are the top three firms, jointly
servicing about 25 percent of all funds with about 25 percent of
total assets. II. Illiquidity Risk and Hedge Fund Returns 8
9. Currently, one of the greatest challenges in the hedge fund
industry is the valuation of funds. Generally, valuation problems
arise when a fund is invested in illiquid assets i.e., assets that
are not traded frequently, and or, easily bought and sold without
major price concessions. Some evidence suggests that fund managers,
who in invest in illiquid assets, smooth their returns. That is,
given the nature of the compensation contracts and performance
measures, managers have an incentive to smooth their returns over
time. To manage returns, managers may mark their portfolios to less
than their actual value in months with high returns to insure their
returns during months with low returns. Alternative explanations
for the serial correlation could be due to a linear extrapolation
from the most recent transaction price (see Germansky, Lo, and
Makarov, 2004). Marking-to-market a fund in this manner will yield
a piecewise linear trajectory in fund value, thereby exhibiting
smoother returns, lower volatility and serial correlation. If there
is a significant presence of liquidity risk in hedge funds, then a
simple examination of monthly returns should provide some insight.
Tables 11 and 12 illustrate the monthly persistence of positive and
negative fund returns over the sample period of January 1991 to
June 2007. These tables show that the monthly persistence does
exist and it is much greater for positive returns than for the
negative returns, which is seemingly consistent to managers
smoothing returns. Moreover, the majority of funds with the
greatest level of persistence in returns are the fixed income
arbitrage funds. Relative to the S&P 500 composite index
performance, hedge funds illustrate similar results (see Tables 13
and 14. III. Some Statistical Analyses A. Correlations Across Hedge
Fund Strategies and Markets With the rapid growth in hedge funds,
regulators along with investors are becoming more concerned with
risks these funds may create in the financial system. Recent
studies have examined contagion effects between hedge funds in
recent years. We do not attempt to provide a comparable study here.
Instead our goal is a much more modest one: to exam the
relationship between trading strategies and market movements. To
investigate the potential hedge funds have to create systemic risk
in a financial system, it is necessary to look at how hedge funds
interact with one another. Table 9 9
10. examines the correlation among hedge fund returns by
strategies. These correlations show that there is a significant
degree of coordination among most trading strategies. As expected,
the riskier trading strategies, such as aggressive growth, emerging
markets, value, technology sector, and opportunistic are highly
positively correlated, and they tend to have moderately positive
correlations with all other strategies. It is also interesting to
note, that independent of the industry, such healthcare, energy,
bonds, or equity, all strategies tend to move in the same
direction. The only two trading strategies that do not move
systemically with other strategies are the CTA/Managed futures and
the Asset Based Lending Strategies. To further investigate the
systemic risks of hedge funds, Table 10 compares movements in
trading strategies for all hedge funds relative to the other assets
categories. The results show that the returns all hedge fund
trading strategies are more widely correlated with High yield,
S&P GSCI Commodity, and REIT market indexes and are less
correlated with the ML Treasury index. Intuitively, the incidence
of correlation between these trading strategies and the former
indexes as opposed to the latter may be due to the over risk
exposure of these markets. It is interesting to note, while the
significance level is quite high the levels of correlations between
these strategies and market returns are usually moderate to low. In
particular, the highest level of correlation with any index for the
largest trading strategy, Funds of funds, is 0.53 with the S&P
GSCI Commodity index, and the level of correlation with the S&P
500 Composite index is only 0.19. B. Relationship between the
Likelihood of an Abnormal Market Movement and Fund Strategy Our
dataset allows us to examine the relationship between selected
characteristics of a fund and its likelihood abnormal market
movements. To a very limited degree, this analysis provides
information about the systemic risks of individual fund strategies.
It does not, however, provide information about the more important
issue of the likelihood of the collapse of several large or many
medium-size hedge funds and the costs such a collapse would impose
directly and indirectly on economies. Yet this is an important
issue. As Schinasi (2006, p. 191) points out, the turbulence
surrounding the near- 10
11. collapse of LTCM in the autumn of 1998 posed the risk of
systemic consequence for international financial system and seems
to have created consequence for real economic activity. This topic
clearly merits further study. The concern with the collapse of LTCM
is not with the fund itself, rather it is the potential impact or
contagion with other funds and possibly other markets. As the
correlation tables illustrate there is a direct association between
returns for different classes of hedges funds and the global
markets. These simple correlations, however, are not the not the
best measure of dependence when a contagious shock is witnessed
(see Embrecht, McNeil, and Strautman, 2002). Therefore, to evaluate
the possible existence of contagion among the different trading
strategies, we draw mainly on the methodology of Eichengreen, Rose,
and Wyplosz (1996), and Boyson, Stahel, and Stulz (2006). For our
study, we use logit analysis to focus on extreme negative returns,
as measured by a negative move in returns of more the two standard
deviations, in broad financial markets and hedge funds to study
contagion. The results of our bi-variate logit regressions are
reported in Table 17. These results show that, in general, when the
hedge funds witness extreme movements the broad market indexes
typically have a higher probability of witnessing an extreme
movement in returns as well. More notably, only the ML treasury
index and the ML corporate bond index are the only markets are not
seemingly influenced by most trading strategies. In terms of
individual strategies, there are some notable relations. For
example, the performance of the funds of funds strategy, which has
the largest number of hedge funds and assets, is significantly
related to downturns in all financial markets. The country-specific
strategy intuitively only relates to the performance of the MSCI
world and MSCI emerging markets indexes. Lastly, the emerging
markets strategy seemingly only relates to the high yield financial
markets. IV. Conclusions The hedge fund industry has grown rapidly
in recent years, in both number and assets. Such funds represent an
important alternative investment vehicle for wealthier and
financially sophisticated investors. They also help improve the
allocation of resources by seeking out exploitable inefficiencies
in firms and markets throughout the world. Hedge 11
12. fund returns have been relatively high over the years, but
so too have been the risks. Indeed, the returns for some funds over
the time periods examined have not compensated for their risk,
compared to other hedge funds employing different strategies. Thus,
investors face different risk-return tradeoffs when investing in
funds employing different strategies. This, of course, should not a
cause for alarm, given the sophistication of investors and lenders
putting money into hedge funds. The fundamental cause for concern
about hedge funds is the degree to which they pose a systemic risk
to the stability of financial markets and economic activity. No one
knows the exact magnitude of this risk. Yet to the degree the
industry has operated for years without causing serious disruptions
in markets and economies, there would appear to be no need for
introducing governmental regulation at this time. After all,
investors can always show their displeasure by withdrawing their
funds. And the banks lending to such funds, as well as the
brokerages and accounting firms servicing them, can take
appropriate action to impose greater market discipline on funds
they suspect are taking on too much risk. The bottom line, in other
words, is let investors beware. 12
13. IV. References Adams, Charles (2005). Hedge Funds and
Financial Market Dynamics: Some Perspectives From the Asian
Experience, Working Paper prepared for Nanyang Technological
University, Singapore. Agarwal, Vikas and Narayan Y. Naik (2000).
Multi-Period Performance Persistence Analysis of Hedge Funds, The
Journal of Financial and Quantitative Analysis, Vol. 35, No. 3.
(Sept., 2000), pp. 327342. Agarwal, Vikas and Narayan Y. Naik
(2000). Performance Evaluation of Hedge Funds with Option-based and
Buy-and-Hold Strategies, Working Paper (August 2000) EFA 0373; FA
Working Paper No. 300. Available at SSRN:
http://ssrn.com/abstract=238708. Agarwal, Vikas and Narayan Y. Naik
(2004). Risks and Portfolio Decisions Involving Hedge Funds, The
Review of Financial studies, Vol. 17, No. 1. 2004. pp. 6398.
Brealey, Richard A. and Evi Kaplanis (2001). Hedge Funds and
Financial Stability: An Analysis of their Factor Exposures,
International Finance ,Vol. 4, No. 2. (2001), pp. 161187. Brown,
Stephen J., William N. Goetzmann, and James M. Park (1998). Hedge
Funds and the Asian Currency Crisis of 1997, Yale School of
Management Working Paper No. F-58 (May 13, 1998). Available at
SSRN: http://ssrn.com/abstract=58650. Brown, Stephen J., William N.
Goetzmann, and Roger G. Ibbotson (1999). Offshore Hedge Funds:
Survival and Performance, The Journal of Business ,Vol. 72, No. 1.
(Jan. 1999), pp. 91117. Chan, Nicholas, Mila Getmansky, Shane Haas,
and Andrew W. Lo (2005). Systemic Risk and Hedge Funds, National
Bureau of Economic Research (NBER) Working Paper No. 11200.
Danielson, Jon, Ashley Taylor and Jean-Pierre Zigrand (2005).
Highwaymen or Heroes: Should Hedge Funds be Regulated?, Journal of
Financial Stability, Vol. 1, No. 4, pp. 522543. Donaldson, William
H. (2003). The Long and Short of Hedge Funds: Effects of Strategies
for Managing Market Risks, Working Paper prepared for the Financial
Services Subcommittee on Capital Markets, Insurance and Government
Sponsored Enterprises, United States House of Representatives.
Edwards, Franklin R. and Mustafa O. Caglayan (2000). Hedge Funds
and Commodity Fund Investment Styles in Bull and Bear Markets,
Journal of Portfolio Management, Vol. 27, No. 4, (2001), pp. 97108.
Edwards, Franklin R. (2003). The Regulations of Hedge Funds:
Financial Stability and Investor Protection, Working Paper prepared
for the Conference on Hedge Funds Institute for Law and Finance /
Deutsches Aktieninstitute. V. Johann Wolfgang Goethe-Univsersitat
Frankfurt, May 22, 2003. Eichengreen, Barry (1999). The Regulators
Dilemma: Hedge Funds in the International Financial Architecture,
International Finance, Vol. 2, No. 3. (1999), pp. 411440.
Eichengreen, Barry and Donald Mathieson (1999). Hedge Funds: What
Do We Really Know? 1999 International Monetary Fund, September
1999. Financial Services Authority of UK (2005). Hedge Funds: A
Discussion of Risk and Regulatory Engagement, Financial Services
Authority of UK, Discussion Paper, June 2005. Fung, William and
David A.Hsieh (1999). A Primer on Hedge Funds,Journal of Empirical
Finance, Vol.6, (1999), pp. 309331. 13
14. Fung, William and David A. Hsieh (2000). Measuring the
Market Impact of Hedge Funds, Journal of Empirical Finance, Vol. 7,
(2000), pp. 136. Fung, William, David A. Hsieh, and Konstantinos
Tsatsaronis (2000). Do Hedge Funds Disrupt Emerging Markets?
Brookings-Wharton Papers on Financial Services: 2000.
Garbaravicius, Tomas and Frank Dierick (2005). Hedge Funds and
Their Implications for Financial Stability, European Central Bank,
Occasional Paper Series No. 34, August 2005. Geithner, Timothy F.
(2006). Hedge Funds and Derivatives and Their Implications for the
Financial System, Speech, Federal Reserve Bank of New York,
September 15, 2006,
http://www.ny.frb.org/newsevents/speeches/2006/gei060914.html
Getmansky, Mila (2005). The Life Cycle of Hedge Funds: Fund Flows,
Size and Performance, Working Paper, January 2, 2005,
http://ssrn.com/abstract=676742. Greenspan, Alan (2005). Remarks by
Chairman Alan Greenspan, Risk Transfer and Financial Stability, the
Federal Reserve Bank of Chicagos Forty-first Annual Conference on
Bank Structure, Chicago, Illinois, May 5, 2005. Kaminsky, Graciela
L., Richard K. Lyons, and Sergio L. Schmukler (2001). Mutual Fund
Investment in Emerging Markets: An Overview, The World Bank
Economic Review, Vol. 15, No. 2. (2001), pp. 315340. Kat, Harry
(2003). 10 Things That Investors Should Know About Hedge Funds, The
Journal of Wealth Management, Spring 2003, pp. 7281. Kim, Woochan
and Shang-Jin Wei (2002). Foreign Portfolio Investors Before and
During A Crisis, Journal of International Economics, Vol. 56,
(2002), pp. 7796. Lhabitant, Francois L. (2004). Hedge Funds
Investing: A Quantitative Look Inside the Black Box, working paper,
EDHEC Risk and Asset Management Research Center, EDHEC Business
School, April 2004. Liang, Bing (2000). Hedge Funds: The Living and
the Dead, The Journal of Financial and Quantitative Analysis, Vol.
35, No. 3. (Sept., 2000), pp. 309326. Lo, Andrew (2001). Risk
Management For Hedge Funds: Introduction and Overview, Financial
Analysts Journal, Vol. 57, No. 6, (November/December 2001).
Lumpkin, Stephen and Hans J. Blommestein (1999). Hedge Funds,
Highly Leveraged Investment Strategies and Financial Markets,
Financial Market Trends, No. 73. (June 1999), pp. 2750. Malkiel,
Burton G. and Atanu Saha (2005). Hedge Funds: Risk and Return,
Financial Analyst Journal, Vol. 61, No. 6. (2005), pp. 8088.
Merrick Jr., John J., Narayan Y. Naik, and Pradeep K. Yadav (2002).
Strategic Trading Behavior and Price Distortion in a Manipulated
Market: Anatomy of a Squeeze, Journal of Financial Economics, Vol.
77, No. 1, (2005), pp. 171218. Napoli Jr., Michael J. (2004). The
Rationale for Hedge Fund Investments, Hedge Fund Styles and Asset
Allocation Issues, working paper, Hedge Funds Group, Wilshire
Research, April 26, 2004. Napoli Jr., Michael J. (2004). The Risks
of Hedge Fund Investments, working paper, Hedge Funds Group,
Wilshire Research, October 26, 2004. Post, Mitchell A. and
Kimberlee Millar (1998). U.S. Emerging Market Equity Funds and the
1997 Crisis in Asian Financial Markets, Perspective, Investment
Company Institute, Vol. 4, No. 2. (June 1998). 14
15. Schinasi, Garry J. (2005), Safeguarding Financial
Stability: Theory and Practice, Washington D.C.: International
Monetary Fund, 2005. Ubide, Angel (2006). Demystifying Hedge Funds,
IMF, Vol. 43, No. 2. (June 2006). Yam, Joseph CK (1999). Capital
Flows, Hedge Funds and Market Failure: A Hong Kong Perspective,
Working Paper prepared for Reserve Bank of Australia 1999
Conference, Capital Flows and the International System, August 910,
1999. 15
16. Table 1: Global, U.S. and Europe Financial System, 2006 US$
Billions World U.S. Europe Rest of the World GDP 48,144 13,245
16,055 18,844 Bank Assets 77,436 13,898 35,541 27,997 Stock Market
Capitalization 54,195 19,426 15,461 19,308 Bond Outstanding 68,147
26,736 24,612 16,799 Currency Derivatives (Notional Amount) 257 169
3 85 Interest Rate Derivatives (Notional Amount) 62,652 37,921
20,562 4,169 Mutual Funds 21,765 10,414 7,734 3,617 Hedge Funds
1,138 579 468 91 Sources: IMF, Emerging Market Fact Book 2007, the
Bank for International Settlements, ICI . 16
17. Figure 1: Numbers, Assets and Returns of All Hedge Funds,
January 1980 to May 2007 Numbers 10,000 8,000 6,000 4,000 2,000 0
81 82 85 88 92 99 04 80 83 84 86 87 89 90 91 93 94 95 96 97 98 00
01 02 03 05 06 07 n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja US$ Billions
Assets 1,400 1,200 1,000 800 600 400 200 0 84 93 00 02 80 81 82 83
85 86 87 88 89 90 91 92 94 95 96 97 98 99 01 03 04 05 06 07 n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n- Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Average Monthly Returns Percent 15 10
5 0 -5 -10 -15 82 83 85 86 88 89 92 06 80 81 84 87 90 91 93 94 95
96 97 98 99 00 01 02 03 04 05 07 n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Table 2: Numbers, Assets, Standard Deviation of Assets, Returns,
Standard Deviation of Returns Across and Across Funds of All Hedge
Funds, 1990 to May 2007 May 199 199 199 199 199 199 2007 1996 1997
1998 1999 2000 2001 2002 2003 2004 2005 2006 0 1 2 3 4 5 , YTD 1,15
1,57 2,10 2,82 3,37 3,99 4,83 5,70 6,75 7,39 7,29 7,14 Number 146
218 312 437 587 842 8 2 6 6 6 7 7 5 1 3 5 4 Total Fund Assets (US$
1,13 1,23 5 8 10 17 20 26 37 61 81 144 176 247 293 518 717 884
Billions) 8 2 Average Fund Assets 34 35 31 40 34 31 32 39 38 51 52
62 61 91 106 120 156 172 (US$ Millions) Standard Deviation of Fund
Assets (US$ 146 127 121 124 142 119 103 111 125 224 192 235 209 263
307 300 386 497 Millions) Average Monthly 1.15 1.90 1.23 2.17 0.41
1.78 1.79 1.64 0.73 2.39 1.05 0.65 0.30 1.33 0.70 0.74 0.94 0.59
Returns (Percent) Standard Deviation of Monthly Return Across 0.76
0.74 0.59 0.68 0.71 0.69 0.71 0.77 1.01 1.09 1.20 0.80 0.62 0.52
0.43 0.41 0.41 0.37 Funds (Percent) 12-Month Standard Deviation of
All Fund 0.92 1.88 0.79 0.92 0.83 1.11 1.49 1.93 2.32 2.15 2.38
1.24 0.86 0.87 1.13 1.26 1.33 0.54 Monthly Return (Percent) 17
18. Figure 2: Numbers, Assets and Returns of Non-Fund-of-Fund
Hedge Funds, January 1980 to May 2007 Numbers 6,000 5,000 4,000
3,000 2,000 1,000 0 80 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
99 00 01 03 04 06 07 81 82 98 02 05 n- n- n- n- n- n- n- n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja US$ Billions Assets 1,000 800 600 400 200 0 92 80 81 82 3 4
85 6 7 88 9 90 91 93 94 95 96 97 98 9 00 1 2 03 4 5 06 07 -8 -8 -8
-8 -8 -9 -0 -0 -0 -0 n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n n n n n n n n n n Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Average Monthly
Returns Percent 20 15 10 5 0 -5 -10 -15 80 81 82 84 85 87 88 89 90
91 93 94 96 97 98 99 00 01 02 03 06 07 83 86 92 95 04 05 n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Table 3: Numbers, Assets, Standard
Deviation of Assets, Returns, Standard Deviation of Returns Across
and Across Funds of Non-Fund-of-Fund Hedge Funds, 1990 to May 2007
May 199 199 199 199 199 199 199 2007 1997 1998 1999 2000 2001 2002
2003 2004 2005 2006 0 1 2 3 4 5 6 , YTD 1,21 1,63 2,18 2,55 2,92
3,42 3,92 4,53 4,93 4,80 4,79 Number 115 169 241 343 455 643 881 0
2 3 3 8 4 7 4 3 8 0 Assets (US$ Billions) 5 7 8 13 15 20 30 50 68
125 148 201 225 366 516 614 784 866 Average Fund Assets 40 41 34 37
33 32 34 41 42 57 58 68 66 93 114 124 163 181 (US$ Millions)
Standard Deviation of Fund Assets (US$ 162 142 136 130 133 115 98
109 125 246 208 259 226 225 273 302 402 534 Millions) Average
Monthly 1.32 2.18 1.32 2.21 0.58 2.06 1.93 1.77 0.89 2.54 1.13 0.75
0.35 1.52 0.79 0.87 1.07 0.62 Returns (Percent) Standard Deviation
of Monthly Return Across 0.91 0.87 0.69 0.77 0.79 0.78 0.81 0.88
1.14 1.23 1.36 0.92 0.72 0.61 0.50 0.49 0.49 0.45 Funds (Percent)
12-Month Standard Deviation of All Fund 1.00 2.36 1.02 0.93 0.75
1.23 1.61 2.06 2.46 2.33 2.60 1.43 0.98 1.03 1.23 1.33 1.40 0.56
Monthly Return (Percent) 18
19. Figure 3: Numbers, Assets and Returns of Fund of Hedge
Funds, January 1980 to May 2007 Numbers 3,000 2,500 2,000 1,500
1,000 500 0 84 80 81 82 83 85 86 87 88 89 90 91 92 93 94 95 96 97
98 99 00 01 02 03 04 05 06 07 n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
US$ Billions Fund of Funds 600 400 200 0 80 81 82 83 84 85 86 87 88
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Average Monthly Returns Percent 15 10 5
0 -5 -10 -15 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
98 99 00 01 02 03 04 05 06 07 n- n- n- n- n- n- n- n- n- n- n- n-
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja Ja Ja
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Table 4: Numbers, Assets, Standard Deviation of Assets, Returns,
Standard Deviation of Returns Across and Across Funds of Fund of
Hedge Funds, 1990 to May 2007 May 1990 1991 1992 1993 1994 1995
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007, YTD
Number 29 46 67 90 128 194 272 357 465 635 817 1,063 1,410 1,775
2,215 2,460 2,487 2,354 Assets (US$ Billions) 0 1 2 5 5 6 8 13 17
25 37 58 81 170 230 308 396 407 Average Fund Assets 14 16 24 54 40
33 31 35 36 39 45 54 58 96 104 125 159 173 (US$ Millions) Standard
Deviation of Fund Assets (US$ 41 37 48 98 175 131 120 118 127 117
124 144 151 310 349 295 352 412 Millions) Average Monthly 0.96 1.08
1.00 2.07 -0.08 1.05 1.49 1.38 0.35 2.03 0.88 0.44 0.21 0.99 0.56
0.58 0.77 1.18 Returns (Percent) Standard Deviation of Monthly
Return Across 0.44 0.35 0.32 0.36 0.44 0.37 0.38 0.37 0.57 0.56
0.66 0.40 0.33 0.28 0.24 0.21 0.18 0.15 Funds (Percent) 12-Month
Standard Deviation of All Fund 0.66 0.72 0.79 1.10 1.17 0.96 1.22
1.58 2.07 1.70 1.85 0.75 0.62 0.61 1.03 1.20 1.30 0.54 Monthly
Return (Percent) 19
20. Figure 4: Risk and Returns by Fund Strategies Average
Monthly Returns, June 1997 to May 2007 3.0 2.5 2.0 1.5 y = 0.1523x
+ 0.721 R2 = 0.4892 1.0 0.5 0.0 0 2 4 6 8 10 12 Standard Deviation
of Monthly Returns 20