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Wednesday, December 8, 2021

The lifecycle of hedge funds, non-directional funds slow (down) faster

Date: Monday, February 4, 2008
Author: SeekingAlpha.com

From SeekingAlpha.com: Deephaven Capital Management, a $4 billion hedge fund, (last week) closed up shop on two of its merger-arb funds. The understandable reason: no one wants anything to do with mergers these days -- except for a certain Microsoft-Yahoo bid. But the rapid decline in the Deephaven funds -- which operated for three years -- may not be all that unusual, a new study out of Germany suggests.

To investigate how returns change over a fund's lifetime, Dieter G. Kaiser of the Frankfurt School of Finance and Management looked at 1,433 hedge funds between 1996 and 2006.

He split them up into two broad categories:

  • Funds which attempted to profit from broad directional movements in markets which include strategies like global macro, long/short equity, emerging markets and distressed assets.
  • Funds which look to profit from mis-pricing opportunities. The strategies these funds use include fixed-income, convertible and merger arbitrage and market neutral strategies.
He found that while excess returns for market directional funds eroded from 2.25 percent to 1.9 percent after three years, there wasn't clear evidence of a life cycle.

The story was different for non-directional funds. They saw a much more dramatic decline in returns from 3.4 percent to 2.1 percent after three years.

Funds that bucked these trends usually had higher returns from the start.

Why does a hedge fund's return typically drop after the first couple of years? New funds have smaller teams which can respond more nimbly to mis-pricings and they're predominately founded in new markets to take advantage of arbitrage opportunities. But as the age old story with any investment strategy goes: once enough people learn about it, the opportunities start to vanish... Full article: Source

The full working paper can be downloaded at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1088845