Risk exposure and survival of individual hedge funds and managed futures funds
The purpose of this research is to investigate risk exposures and survival of individual hedge funds and managed futures funds both within and between strategy styles. There are two immediate new contributions: (1) a comprehensive database of hedge fund and managed futures funds comprised from the major database vendors; each database has been used singly or lesser combination by previous researchers, and (2) analysis of the variation of risk exposures of individual funds as opposed to portfolios or indices.
The research focuses on three areas: (1) estimating statistical properties and survivorship bias, (2) estimating common economic/market risk factor exposures and variation, and, (3) providing evidence of survival patterns.
The first part confirms previously documented properties of hedge fund returns. The results for survivorship bias estimation using the two main estimation methods, MaIkiel (1995) and Ackerman, McNally, and Ravenscraft (AMR) (1999), are problematic due to poor estimation of the magnitude of survivorship bias, and/or, inadequate value for adjusting actual portfolio returns. However, by employing a hybrid method of estimation, combining the AMR method and a fund-of-funds approach suggested by Fung & Hsieh (2000), survivorship bias estimates of approximately 2% annually are obtained.
The second part utilizes multi-factor modeling with common macroeconomic and market risk factors. Hedge fund results are consistent with major strategy style; total risk exposure is greatest for Opportunistic strategies, followed by Event Driven, Relative Value, and Fund of Funds strategies. The source of return for Managed Futures funds derive from completely different patterns (and perhaps sources) of risk (consistent with Schneeweis & Spurgin (1998, 1999), and others). In addition, the risk of some strategies are clearly not well represented by the risk factor structure used for this research; the model is underspecified.
The third part uses the technique of the second part on a sample of surviving and non-surviving funds during a time period of market distress. Results indicate that non-surviving funds have risk factor exposures that are about twice the magnitude of their surviving counterparts; funds with the greatest risk exposures are the funds most likely to dissolve.