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Funds investing in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth these funds' returns when evaluating their risk exposures. We show that funds with similar investments share a common source of spurious autocorrelation not fully resolved by traditional unsmoothing methods and thereby leading to underestimation of systematic risk. Thus, we propose a generalized unsmoothing technique and apply it to hedge funds and private commercial real estate funds. Our method significantly improves the measurement of funds' risk exposures and risk-adjusted performance, especially for highly illiquid funds. Overall, the average illiquid fund alpha is lower than previously thought. (JEL G11, G12, G23) [ABSTRACT FROM AUTHOR]

The number of short campaigns by hedge funds has dramatically increased over the last two decades. Nearly 80% of campaigns are undertaken by activist hedge funds, particularly those that employ hostile tactics in their long campaigns. Short campaigns are associated with negative abnormal returns of –7%, with aggregate valuation effects similar in magnitude to the gains from long activism campaigns. In contrast to long campaigns, public communication is a critical component of short campaigns. We do not find evidence that such communication is manipulative. Overall, our analysis highlights the importance of short campaigns for understanding the economic impact of activist hedge funds. [ABSTRACT FROM AUTHOR]

We analyze a model in which an anomaly is unknown to arbitrageurs until its discovery, and test the model implications on both asset prices and arbitrageurs' trading activities. Using data on 99 anomalies documented in the existing literature, we find that the discovery of an anomaly reduces the correlation between the returns of its decile-1 and decile-10 portfolios. This discovery effect is stronger if the aggregate wealth of hedge funds is more volatile. Finally, hedge funds increase (reverse) their positions in exploiting anomalies when their aggregate wealth increases (decreases), further suggesting that these discovery effects operate through arbitrage trading. [ABSTRACT FROM AUTHOR]

Hedge fund teams with heterogeneous educational backgrounds, academic specializations, work experiences, genders, and races, outperform homogeneous teams after adjusting for risk and fund characteristics. An event study of manager team transitions, instrumental variable regressions, and an analysis of managers who simultaneously operate solo- and team-managed funds address endogeneity concerns. Diverse teams deliver superior returns by arbitraging more stock anomalies, avoiding behavioral biases, and minimizing downside risks. Moreover, diversity allows hedge funds to circumvent capacity constraints and generate persistent performance. Our results suggest that diversity adds value in asset management. Authors have furnished an Internet Appendix , which is available on the Oxford University Press Web site next to the link to the final published paper online [ABSTRACT FROM AUTHOR]

We propose and test a framework of private information acquisition and decision timing for asset allocators hiring outside investment managers. Using unique data on due diligence interactions between an institutional allocator and 860 hedge fund managers, we find that the production of private information complements public information. The allocator strategically chooses how much proprietary information to collect, reducing due diligence time by 18 months and improving outcomes. Funds selected by the manager outperform those not selected by 9 |$\%$| over 20 months. The outperformance relates to the allocator learning about fund return-to-scale constraints and manager skill before other investors. [ABSTRACT FROM AUTHOR]

This article is an interview with Clifford S. Asness, the founder of AQR Capital Management, LLC. Asness discusses his firm's investment strategy, which is based on economic theory and supported by statistical evidence. He emphasizes the need for a disciplined approach to investing and avoiding data mining. Asness also highlights the key performance indicators he prioritizes, such as separating alpha from beta and focusing on risk-adjusted returns. He discusses the role of risk management and technology in asset management strategies. Finally, he addresses the challenge of balancing client expectations with market dynamics and investment performance. Asness also discusses the importance of sharing research and insights with investors, the influence of environmental, social, and governance (ESG) factors on investment strategies, and the impact of global economic trends on investment decisions. He emphasizes the importance of diversification to mitigate risk and reflects on his experiences that have shaped his approach to investment management. He offers advice to aspiring Chief Investment Officers (CIOs), emphasizing the role of luck and the importance of learning from challenging times. [Extracted from the article]

While it is established that idiosyncratic volatility is negatively priced in the cross-section of stock returns, the relation between idiosyncratic volatility and hedge fund returns is largely unexplored. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6 percent p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds' idiosyncratic volatility is a measure of managerial skill. [ABSTRACT FROM AUTHOR]

We examine the impact of hedge fund activism (HFA) on the investment efficiency of target firms. We find that target firms' investment efficiency improves after the active involvement of hedge funds. This improvement is mainly evident for HFA campaigns with investment strategy-related reforms as one of the main stated objectives. Among investment strategy-related HFA campaigns, the changes in investment efficiency are more pronounced when hedge funds obtain board representation or privately settle with target firms. HFA improves the investment efficiency of target firms by mitigating overinvestment rather than underinvestment problems. Additional tests reveal that target firms with no resistance to HFA and higher free cash flow accommodate this improvement in investment efficiency following HFA. Overall, our findings highlight the role of HFA as a governance mechanism in improving investment efficiency and influencing managers to reduce overinvestment. [ABSTRACT FROM AUTHOR]

This paper proposes a predictive approach to forecast future hedge fund performances and reporting stops to a commercial database within a subsequent year. We found that gradient boosting of decision trees is well suited to make a prognosis about the future development and reporting stops of hedge funds. The derived models are trained and evaluated using a panel of 5,592 individual hedge funds. We rank the impact of 22 variables that are computed out of hedge fund reporting (micro variables) and three different market environments (macro variables) on the predictability of hedge fund performance. In this way, we show the economic reasonability of the computed models and demonstrate the superiority of statistical learning algorithms. [ABSTRACT FROM AUTHOR]

The article provides understanding of the effect of carried interest provisions on fairness and equality in the taxation of hedge fund profits. Topics discussed include foundational principles of the U.S. tax system, beneficiaries of the carried interest tax provisions, public and congressional response to the tax treatment of carried interest, taxation of carried interest as ordinary income and limitation of carried interest earned on domestic investments if it is taxed at capital gains rate.

Purpose: Applying the concept of "entrepreneur managers" from dynamic capabilities theory to the question of how some Japanese managers develop and use their relationships with foreign investors, this article explores organizational contexts in which Japanese managers use foreign shareholders as resources to enhance firm capabilities in the global marketplace, deploy assets effectively and implement changes to traditional organizational customs. The article asks why and how some top managers implemented institutional changes and adopted customs that are common in the shareholder-based system while others did not. Design/methodology/approach: We conducted qualitative interviews with 11 inverstor relations (IR) managers of large, listed Japanese firms in Kyoto and Tokyo. Findings: First, by inviting a hedge fund partner and using their human capital and social capital, a Japanese CEO committed to strengthening his firm's competencies in the global market and introduced changes that are common in the shareholder-based system. Second, a CEO with an MBA degree and exceptional communication skills in English and Japanese dedicated himself to executing much of the strategic advice suggested to him by foreign shareholders and altered some of his firm's traditional Japanese management practices. Third, even though many Japanese firms welcomed and used foreign shareholders as advisors to help them streamline and/or acquire firm assets, their top leaders' implementation of organizational changes was limited. Fourth, the top leaders of family-owned firms were reluctant to initiate dialogue with foreign investors. Originality/value: This article adds some useful organizational context to existing scholarship on institutional theory by examining Japanese leaders' strategic management in their relations with foreign investors. Using the concept of dynamic capabilities, it addresses the role of innovative strategic managers in firms' institutional changes. [ABSTRACT FROM AUTHOR]

Research Summary: This article examines the antecedents and outcomes of hedge fund activism in family versus nonfamily firms. We find that activist hedge funds are less likely to initiate campaigns against family firms than nonfamily firms, but the cumulative abnormal returns to announcements of campaigns against family firms exceed those of nonfamily firms. The presence of one or more family members on a firm's board of directors appears to be a key impediment to hedge fund activism in family firms. Additionally, activist hedge funds are more likely to use hostile tactics and demand more substantive changes in their campaigns against family firms than nonfamily firms. Together, these findings contribute to the agency theory‐based literatures on hedge fund activism, family firms, boards of directors, and corporate governance. Managerial Summary: Activist hedge funds are a significant force in corporate governance, driving the companies they target to change their strategies, structures, and leadership. Family firms are prevalent and economically important, accounting for a third to a half of companies worldwide. This article compares hedge fund activism in family versus nonfamily firms. Activist hedge funds are about 41% less likely to initiate campaigns against family than nonfamily firms, but the average returns to successful activist hedge fund campaigns against family firms are about 2% higher than in nonfamily firms. These effects are especially pronounced when family members serve on a company's board of directors. Furthermore, activist hedge funds are more likely to use hostile tactics and demand more substantive changes in campaigns against family than nonfamily firms. [ABSTRACT FROM AUTHOR]

Using monthly data from 1997 to 2023, we construct mean-variance optimized portfolios of common university endowment asset classes, including domestic equity, international equity, global bonds, hedge funds, private equity, real estate, and natural resources. We find substantial variation in optimal allocations to these asset classes across subperiods. Some asset classes are substantially more persistent in receiving allocations than others, while some asset classes rarely receive sizable allocations at all. Our results highlight the relevance of asset allocation in portfolio performance and may inform future decisions by institutional investors and endowment portfolio managers. [ABSTRACT FROM AUTHOR]

We examine the impact of activist hedge fund campaigns on corporate Intangible Capital (IC) investments, a key determinant of corporate long-term growth and performance. We document that post-activist campaigns, targeted firms reduce IC investments by more than 10% compared to carefully matched non-target firms. In cross-sectional analyses, we observe the largest effects in less competitive industries, for older target firms and for firms with high financial constraints suggesting that IC cuts are more common in low-discipline and low-barriers-to-invest contexts. Hedge funds are cutting down IC investments when they engage both in relatively short and longer interventions but especially so when they have less industry investment experience. Further, we do not find evidence of post-intervention increased investment efficiency in targeted firms, casting some doubt on the longer-term value-added of activist IC slashing campaigns. Finally, in an attempt to identify where the saved IC resources post intervention flow to, we observe that targeted firms increase corporate payouts and prefer share repurchase programs above cash dividends. [ABSTRACT FROM AUTHOR]

Hedge fund managers' risk-taking choices are influenced by their compensation structure. We differ from most studies that focus on incentive fees and the high-water mark by examining how management fees affect managers' risk-taking. Our simple model shows that managers' risk-taking is negatively related to their future management fees. Using fund-level data, we find that future management fees are the dominant component of managers' total compensation. When the contribution of future management fees increases, managers reduce risk-taking to increase survival probabilities. Moreover, funds with higher decreasing returns to scale are more sensitive to future management fees and reduce risk-taking even more. Authors have furnished an Internet Appendix , which is available on the Oxford University Press Web site next to the link to the final published paper online. [ABSTRACT FROM AUTHOR]

In the dynamic sphere of financial markets, hedge funds have emerged as a critical force, navigating through volatility with advanced risk management techniques yet grappling with the challenges posed by illiquid assets. This study aims to transcend traditional option pricing models, which struggle under the complexities of hedge fund investments, by exploring the applicability of machine learning in financial risk management. Leveraging Deep Neural Networks (DNNs) and Long Short-Term Memory (LSTM) cells, the research introduces a model-free, data-driven approach for discrete-time hedging problems. Through a comparative analysis of simulated data and the implementation of LSTM architectures, the paper elucidates the potential of these machine learning techniques to enhance the precision of risk assessments and decision-making processes in hedge fund investments. The findings reveal that DNNs and LSTMs offer significant advancements over conventional models, effectively capturing long-term dependencies and complex patterns within financial time series data. Consequently, the study underscores the transformative impact of machine learning on the methodologies employed in financial risk management, proposing a novel paradigm that promises to mitigate the intricacies of hedging illiquid assets. This research not only contributes to the academic discourse but also paves the way for the development of more adaptive and resilient investment strategies in the face of market uncertainties. [ABSTRACT FROM AUTHOR]

Hedge funds earn positive ex post abnormal returns and avoid negative abnormal returns on their equity portfolios when trading in the opposite direction of highly diversified low-turnover institutional investors (quasi indexers). This pattern seems to be driven by the preferences of quasi indexers for high-market-beta stocks together with the ability of hedge funds to identify subsets of especially profitable trades. It remains pronounced when accounting for other determinants of hedge fund trades, such as stock liquidity, market anomalies, and major corporate events. Trading against other institutional investors or noninstitutions does not result in abnormal performance for hedge funds. This paper was accepted by David Sraer, finance. Supplemental Material: Data and the online appendix are available at https://doi.org/10.1287/mnsc.2023.4877. [ABSTRACT FROM AUTHOR]

Using fund returns and fund stockholdings, we investigate whether fund managers follow fundamental analysis strategies. We show that hedge fund and mutual fund returns tend to load negatively on the long-short returns of a comprehensive sample of fundamental strategies (i.e., accounting anomalies), suggesting that fund managers are prone to trade in the opposite direction of what fundamental strategies prescribe. The negative loadings are primarily driven by the short-leg of the anomalies, more pronounced for contrarian-like anomalies, and more prevalent among earnings quality, investment, external financing, value, and profitability-based anomalies. We show that funds with higher anomaly loadings perform significantly better. Our results suggest that fund managers, as a group, do not systematically pursue fundamental analysis strategies, perhaps due to agency concerns, but a subset of managers are skilled and profit from employing such strategies. We find similar results when examining the stockholdings of hedge funds and mutual funds. Our findings have important implications for the persistence of accounting anomalies, sophistication of institutional investors, and investment value of fundamental analysis. [ABSTRACT FROM AUTHOR]

Substantial remunerative benefits accrue to managers of new hedge funds launched after the implementation of the Volcker Rule if their previous employer is a large US bank. After the rule, ex‐bankers' funds charge higher management fees and receive more flows as compared with other new hedge funds established during the same period. This phenomenon is related to changes in investor perception of the distribution of skills of new fund managers rather than to the actual differences in skills. Ex‐bankers' funds are indistinguishable from other funds in terms of performance, risk, and liquidation probability, both before and after the Volcker Rule. [ABSTRACT FROM AUTHOR]

The literature on dual holding focuses exclusively on cases where the holder is primarily a creditor and buys the firm's stocks to reduce potential wealth transfer. However, wealth transfer is not a concern when the dual holder is a stockholder first and becomes a bondholder later. We hypothesize that the principal motive behind such dual holdings is to provide debt funding to an otherwise successful firm that cannot fund good projects because of internal capital allocation problems coupled with external capital constraints. We select samples from multinational corporations based on evidence that these firms are exposed to domestic underinvestment because they are reluctant to bring back foreign profits to avoid repatriation taxes. We choose hedge funds (HFs) as dual holders. The treatment group comprises firms where HFs are dual owners, and the control group comprises firms in which HFs own stocks only. The treatment group experiences steeper financial constraints, leading to deeper underinvestment problems and causing target firms to seek HF funding. The funding corresponds well to the amount of underinvestment. Targets improve investment efficiency by alleviating underinvestment, surpassing their predual performance and the control group's postdual performance. [ABSTRACT FROM AUTHOR]

This article challenges the contemporary negative and dismissive narratives about distressed debt hedge funds (DDHFs), a subset of holdout creditors. A soft normative framework for regulating this category of creditors and other holdout creditors is however proposed to address their disruptive activities in the sovereign debt market. It is proposed that the Basel III framework be a conduit for enforcing the proposed normative framework because hedge funds are customers of institutions subject to Basel III oversight. One of the characteristics of these funds is their relatively sophisticated and high use of leverage. The authors therefore envisage the Basel III framework being expanded to provide for enforcement in this context. Finally, the normative framework proposed in this article differs from previous proposals including the Sovereign Debt Restructuring Mechanism (SDRM) and contractual solutions including Collective Action Clauses (CACs) and exit consents as it proposes the Basel III framework as an enforcement mechanism and is not a contractual solution. [ABSTRACT FROM AUTHOR]

Mandatory filings for UK hedge funds suggest that managers having worked at the same prior employer invest more similarly in terms of distances of returns. If they overlapped in employment, increasing the chance of social ties, investments become even more similar. The joint effect accounts for up to two thirds of the difference in investing behavior. Results are robust to fund- and manager-level controls as well as to identification concerns. With controls, the same-employer effect is concentrated in the systematic component (beta), whereas the overlap effect is concentrated in the idiosyncratic components (alpha and residuals). Managerial ties make any two funds more similar in their stock holdings. Moreover, portfolios of connected funds outperform their peers in terms of alpha, return volatility, and Sharpe ratio. This paper was accepted by Victoria Ivashina, finance. Supplemental Material: The data file is available at https://doi.org/10.1287/mnsc.2023.4843. [ABSTRACT FROM AUTHOR]

I test the hypothesis that the use of leverage by market speculators can increase the likelihood and magnitude of crashes in asset prices. Using a direct leverage measure derived from US public filings, I find that (1) stocks held by highly leveraged hedge funds subsequently have more negatively skewed returns than stocks held by less leveraged funds and (2) upon extremely negative earnings surprises or funding liquidity shocks, stocks owned by high-leverage funds exhibit abnormal price declines and subsequent reversal. Consistent with the fire sale and contagion hypothesis, high-leverage funds tend to reduce the position following negative news about a stock, and such selling can extend to other stocks in the portfolio, increasing the crash proneness of the stocks they hold. [ABSTRACT FROM AUTHOR]

This research study provides insights on how activist hedge funds perform valuation analyses of target firms. Relevant data was hand‐collected from a sample of activist hedge fund presentations. Based on the hedge funds' valuation analyses, the undervaluation of the target firms amounts to approximately 30%, compared to the targets' current share price. Besides, activist investors derive a value enhancement potential from their proposed strategies of approximately 70% to the targets' current share price. These valuation results rely predominately on trading multiples. The dominant multiples are Enterprise value/EBITDA (EV/EBITDA) and Price/Earnings (P/E). Further, applied multiples are mainly forward‐looking, and the predicted performance measures are primarily consensus estimates. Besides, hedge funds sometimes adjust multiples arbitrarily to increase the comparability. Our results confirm that short‐term investors rely predominately on pricing analyses in their valuations. [ABSTRACT FROM AUTHOR]

We present a framework for linking hedge funds to environmental, social, and governance (ESG) investments based on systematic ESG risk. We proposed a double-factor model to explain the co-movement of asset returns due to two systematic risk factors: Adjusted market risk and systematic ESG risk. Complementing prior work that introduces ESG characteristic indicators as determinants of agents' utility functions, this framework leverages modern portfolio theory by establishing a channel through which systematic ESG shocks affect asset risk and, in turn, equilibrium expected returns. This approach enabled us to estimate empirical market prices for systematic ESG risk from real-world observations and derive the relationship between equilibrium expected returns and the loadings on systematic risk factors. Applying this framework to U.S. equity mutual funds, we found that the loadings of systematic ESG risk were significantly correlated with the expected return of the sorted portfolios. These results suggested that it is possible to design hedge fund strategies that capitalize on systematic ESG risk that varies over time. [ABSTRACT FROM AUTHOR]

Blockholder disclosure thresholds shape incentives for hedge fund activism, which are jointly determined with real investment and managerial behavior. Uninformed investors value lower thresholds (greater transparency) when the cost of trading against an informed activist outweighs the benefits of the activist's disciplining of management. Conversely, activists may desire disclosure thresholds if the threat of their participation discourages managerial malfeasance, which is their source of profits. Hedge fund activism can be excessive: If market opacity sufficiently harms uninformed investors, the costs of reduced real investment outweigh the social benefits from managerial disciplining, and society benefits from lower thresholds. [ABSTRACT FROM AUTHOR]