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This paper specifies a simulated convertible bond arbitrage portfolio to characterise the risks in convertible bond arbitrage. For comparison the risk profile of convertible bond arbitrage hedge fund indices at both monthly and daily frequencies is also examined. Results indicate that convertible bond arbitrage is positively related to default and term structure risk factors. These risk factors are augmented with the simulated convertible bond arbitrage portfolio, mimicking a passive investment in convertible bond arbitrage, to assess the risk and return of individual hedge funds. We provide estimates of the performance of two hedge fund indices (an equally weighted and value weighted index) and a sample of convertible bond arbitrage hedge funds using a factor model methodology. Lagged and contemporaneous observations of the risk factors are specified, controlling for illiquidity in the securities held by funds. Our results cover two time periods. Initially we find evidence of abnormal risk adjusted returns in the individual hedge fund data and the equally weighted hedge fund index and no evidence of abnormal risk adjusted returns in the value weighted hedge fund index. When we examine performance during the credit crisis of 2007 and 2008 we find evidence of negative abnormal returns amongst individual hedge funds and the hedge fund indices.

There is a growing literature examining futures based trading strategies and the performance of Commodity Trading Advisors (CTAs). In this paper, we test the validity of three key assumptions used in these studies. The validity of basing conclusions on analysis of synthetic rather than market price data is tested. We review the evidence on the level of transaction costs to test the cost model used in modelling futures based trading strategy. Finally, we test the assumption that CTAs generally charge a management fee of 2% and incentive (performance) fee of 20%. In addition, the trend over time in the structure of fees is presented. Our findings suggest that inferences based upon synthetic futures replicate those based on exchange-traded data. Over the full period, the average fee levels were measured at 1.82% (management) and 20.2% (incentive) close to and not significantly different from the levels used in the literature.

The time series momentum strategy has been shown to deliver consistent profitability over a long time horizon. Funds pursuing these strategies are now a component of many institutional portfolios, due to the expectation of positive returns in equity bear markets. However, the return drivers of the strategy and its performance in other economic conditions are less well understood. The authors find evidence that the returns to the strategy are connected to the business cycle. Returns are positive in both recessions and expansions, but profitability is especially high in expansions. About 40% of returns are due to time varying factor-related risk exposure, consistent with rational asset pricing theories having a role in explaining the profitability of the strategy.

We investigate the pricing of systematic liquidity risk in UK equities using a large sample of daily data. Employing four alternative measures of liquidity we first find strong evidence of commonality in liquidity across stocks. We apply asymptotic principal component analysis (PCA) on the sample of stocks to extract market or systematic liquidity factors. Previous research on systematic liquidity risk, estimated using PCA, is focused on the US, which has very different market structures to the UK. Our pricing results indicate that systematic liquidity risk is positively priced in the cross-section of stocks, specifically for the quoted spread liquidity measure. These findings around the pricing of systematic liquidity risk are not affected by the level of individual stock liquidity as a risk characteristic. However, counter-intuitively, we find that the latter is negatively priced in the cross-section of stocks, confirming earlier research.

This paper studies the relation between return skewness, fund flows, and hedge fund performance. Our results show that hedge fund returns exhibit significant skewness and fund investors prefer skewness. Annual flows into hedge funds with positively skewed returns are 11.5% higher than comparable funds with negatively skewed returns. Evaluating hedge fund performance using a new performance measure that accounts for return skewness leads to superior ex-ante fund selection. During the 1994 to 2009 period, the average improvement in out-of-sample annual performance is 2%. Our measure is particularly valuable during periods of economic crisis when returns are more likely to exhibit skewness and the improvement in annual performance is about 4%.

Following large positive returns in 2008, Commodity Trading Advisors (CTAs) received increased attention and allocations from institutional investors. Subsequent performance has been below its long term average. This has occurred in a period following the largest financial crisis since the great depression. In this paper, using almost a century of data, we investigate what typically happens to the core strategy pursued by these funds in global financial crises. We also examine the time series behaviour of the markets traded by CTAs during these crisis periods. Our results show that in an extended period following financial crises trend following average returns are less than half those earned in no-crisis periods. Evidence from regional crises shows a similar pattern. We also find that futures markets do not display the strong time series return predictability prevalent in no-crisis periods, resulting in relatively weak returns for trend following strategies for, on average, four years following the start of a financial crisis.

92 percent of hedge funds in the TASS database have returns which exhibit systematic skewness so the alpha of the managers of these hedge funds is difficult to estimate with OLS. To control for skewness the Residual Augmented Least Squares (RALS) estimator is specified to measure the performance of these hedge funds. We demonstrate that the OLS performance assessment error depends systematically on skewness, is economically significant, and that RALS is not sensitive to this bias. Furthermore, portfolios formed on RALS alphas are more persistent than those formed on OLS alphas, particularly during crisis periods.

Returns of hedge funds generally exhibit non-normality. It is well documented that if asset returns have systematic skewness, expected returns should include rewards for accepting this risk. This skewness risk premium should be controlled for in any estimate of performance. To investigate this issue we specify the Residual Augmented Least Squares (RALS) estimator, designed to exploit non-normality in a time series’ distribution. Specifying a linear factor model, we provide robust estimates of hedge fund performance, demonstrating the increase in efficiency of RALS relative to OLS estimation. Our evidence suggests that measuring performance using OLS alphas is inefficient, understating the performance of some hedge funds and overstating the performance of others. We then examine the source of the OLS mispricing. We find that the level of mispricing is positively related to estimates of skewness in the historical fund returns. We conclude that when estimated by OLS the performance of managers who pursue a strategy exhibiting positive skewness is understated and those whose strategy exhibits negative skewness is overstated. Estimation by RALS overcomes this. Our findings are robust to the biases in hedge fund databases.

This paper replicates the core underlying merger arbitrage strategy using daily data from the United Kingdom to generate three simulated merger arbitrage portfolio return series, for the period 2001 through to 2004. Past empirical evidence indicates that the merger arbitrage strategy generates large risk adjusted returns. More recent evidence indicates that the strategy has a return distribution equivalent to a short put option on a stock index. These prior studies have generally focused on monthly returns in the North American stock markets. For the UK market we find evidence that the merger arbitrage strategy exhibits little systematic risk and generates significant risk adjusted returns. Contrary to prior research we find no evidence of an increase in systematic risk in depreciating equity markets.