9: Manager selection, DD, Regulation Flashcards
Moneyness
Moneyness = NAV / high watermark
If less than 1, the manager’s option is out of the money.
Traits of funds likely to liquidate
- Young
- Poor Performance
- Low AUM
- Short lock up
- Short redemption notice
- No high watermark
Method to construct contingency tables (to test for persistence)
- calculate median performance variable
- categorize each manager as W or L (vs. median)
- count # of times W in P1 is W in P2 etc.
- compute cross product ratio (no persistence if CPR=1)
- test CPR for statistical significance
Results of Test for Persistence
- no performance persistence
- strong persistence found in risk (except for merger arb)
Omega ratio
- used for monitoring
- high omega preferred
Hurst exponent
- measure of persistence
- high H preferred
- 0 < H < 0.5: mean reverting
- 0.5 < H < 1: persistent performance
- 0.5: random returns
D-statistic
- measure of downside risk
- D = 0: no downside risk
- D = 1: no positive returns
- low D preferred
Calmar Ratio
Ratio of returns to drawdown
Carpenter (2000)
- managers increase risk as fund value drops
- managers increase risk below hurdle rate
- assumes fund liquidation @ value = 0
Goetzmann, Ingersoll and Ross (2003)
- managers reduce risk as fund value drops
- emphasis on avoiding liquidation
- assumes fund liquidation is possible before value = 0
Panageas and Westerfield (2009)
- no adjustments when returns are higher or lower
- managers compensated with incentive fee and HWM keep a constant proportion in the risky asset,
Hodder & Jackwerth (2007)
- managers increase risk when returns are low, then decrease as fund grows
- find a liquidation barrier and having managers invested inhibits excessive risk taking as fund value decreases
- slight changes to the compensation structure can have significant effects on the risk-taking behavior of managers
Tournament Behavior
- funds with below-median returns in 1H have increased volatility in 2H
- Found to be true in mutual funds and hedge funds
Empirical findings (risk behavior) based on relative performance
- Managers with poor performance increased risk (to improve rankings)
- Managers with strong performance decreased risk (to maintain rankings)
Empirical findings (risk behavior) based on absolute performance
- ITM - reduce risk (‘locking in’ behavior)
- ATM - increase risk
- OTM - reduce risk (do not ‘put it all on black’)
UCITS Eligible Instruments
- Permitted: stocks & bonds, s & b derivatives
- Permitted in many regions: investing in indices based on non-eligible assets
- Not permitted in most regions: physical commodities or associated certificates
- Not permitted anywhere: HFs, PE, RE
- Luxembourg: can invest in closed end REIT funds and closed-end HFs
Trash Ratio
10% of portfolio can be in non-eligible assets
Issues with using VaR as risk management tool
- does not account for extreme events
2. depends on normal returns
Non-sophisticated UCITS funds
long only funds, may use derivatives for hedging
Sophisticated UCITS funds
use derivatives for investing; more risk management
Alternative UCITS funds vs HFs
- Performance comparable to HFs
- Outperform investable HF indices
- Less risk than HFs (due to leverage limits)
- Less exposure to illiquid assets than HFs
Relationship with HF size, age, survival and risk taking?
size: no
age of fund: no
Weak evidence that smaller and young funds are more likely to engage in “locking in” behavior following relatively poor performance or when significantly below HWM. Makes sense given that liquidation concerns are more of a concern for this group
Qualification criteria for UCITS
open ended liquid well-diversified invest only in eligible assets use limited leverage
UCITS key points
- PE, HF, and RE are not permitted
- 10% trash ratio: this is for ineligible assets
- Short positions can only be constructed synthetically using derivatives
- In UCITS FoFS, individual investments cannot exceed 20% of NAV or 30% in non-UCITS funds
- must allow 20% of NAV to be redeemed at any time
- must value investments 2x a month
- must offer min. 2 redemptions per month to clients
- must provide NAV to authorities 2x a week
- must publish NAV 2X a month to investors
-no selection, survivorship or instant history bias - when identifying leverage levels:
Un-Sophisticated UCITS use commitment approach, 200% leverage on NAV (via derivatives)
Sophisticated UCITS use VaR approach - can hold illiquid instruments (up to 10% of NAV) as long as they can meet the expected redemption requests from investors
