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Review of Accounting Studies

Erschienen in:

12.05.2017

Do risk management practices work? Evidence from hedge funds

verfasst von: Gavin Cassar, Joseph Gerakos

Erschienen in: Review of Accounting Studies | Ausgabe 3/2017

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Abstract

We examine hedge fund risk management practices and their association with left-tail risk during the 2008 financial crisis. Consistent with risk management practices reducing left-tail risk, funds in our sample that use formal risk models performed significantly better in the extreme down months of 2008. We find no evidence that having either position limits or a dedicated head of risk management is associated with reduced left-tail risk. Funds employing value at risk models had more accurate expectations of how they would perform in a short-term equity bear market.

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Ang et al. (2014) make a similar point regarding endowments’ investments in alternative assets: a lack of information regarding outcomes in future states inhibits optimal portfolio choices.

For example, see Geczy et al. (1997), Guay (1999), Allayannis and Ofek (2001), Allayannis et al. (2001), Kim et al. (2006), Geczy et al. (2007), Ellul and Yerramilli (2013), and Treanor et al. (2014).

A potential concern with the database is that it consists only of funds willing to be subject to due diligence. According to the vendor, refusals of due diligence are, however, rare.

As pointed out by both the data vendor and Brown et al. (2012), 6 percent of the managers in the database misrepresent their backgrounds. Although we limit our primary analysis to measures verified on-site by the data vendor, it could be the case that the some managers are able to misrepresent their risk management practices. However, any misrepresentation of risk management practices likely biases our tests against finding significant differences between funds that do and do not implement the various risk management practices.

For a discussion and comparison of these databases, see Agarwal et al. (2011). Cassar and Gerakos (2010) also use HFDD funds to investigate internal controls.

Similarly, commercial databases are likely not to be representative of the entire population of hedge funds given the voluntary choice of funds to self-report performance returns to commercial databases (Agarwal et al. 2013).

Because of differences in how the funds reported leverage levels (e.g., gross versus net leverage and typical versus maximum leverage), we use a simple indicator variable to capture whether the fund uses explicit leverage.

We find similar results when we treat the risk officer’s trading authority as a nominal choice and estimate the determinants using multinomial logit.

We find similar results when we treat investment limits as a nominal choice and estimate the determinants using multinomial logit.

Even though the return on the S&P 500 Index was slightly positive and slightly negative for July and August, the coefficients on models are significantly positive for these two months. The positive and significant coefficients for July and August are, however, consistent with the fact that the return on the HFR Composite Index was negative for both months (July, −2.3%; August, −1.4%).

In unreported tests, we find similar results when we carry out multivariate comparisons.

When we examine monthly performance over the period starting January 2005 through December 2010, we find limited evidence that funds using risk models perform worse in months in which the S&P 500 Index had large positive returns. For example, for months in which the S&P 500 Index gained 5 percent or more, funds using at least one model under performed funds that use no models by 1.7 percentage points. These results, however, involve small sample sizes and are sensitive to the empirical specification and sample selection.

Given the relatively small number of managers with doctorates, we do not categorize doctorates by whether they are in technical subjects or in business or economics.

We find similar results when we adjust using the relevant HFR style index.

We find similar comparisons between the univariate and multivariate estimates for the other months of 2008 in which the S&P 500 Index lost 5 percent or more. In addition, for the months in which the coefficients on models are statistically significant, the p-values of the regressions decrease and the adjusted R ²s increase.

Later in the sample period, HedgeFundDueDiligence.com increased the categories to include −3 “Down a lot” and +3 “Up a lot.” We coded such responses as −2 and +2.

See Bollen and Pool (2008) and Cassar and Gerakos (2011).

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Titel: Do risk management practices work? Evidence from hedge funds
verfasst von: Gavin Cassar
Joseph Gerakos
Publikationsdatum: 12.05.2017
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 3/2017
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-017-9403-5

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