Secondary market research reveals deep links between hedge fund and closed-end mutual fund industry

Date: Friday, June 19, 2009

Investor behaviour in the hedge fund market can be better analysed by drawing on insight from the closed-end mutual fund market, according to Dr Tarun Ramadorai, Reader in Finance at the Said Business School of Oxford University.

Speaking at the GAIM International Conference, Dr Ramadoria said research carried out over the last decade has uncovered startlingly similar trends within the hedge fund market and the closed-ended mutual fund market. Using data provided by secondary hedge fund market provider Hedgebay Trading Corporation, which matches sophisticated buyers and sellers of hedge fund interests and other illiquid alternative investment assets, Dr Ramadorai has analysed the factors that determine whether a trade on Hedgebay takes place at, or at a premium or discount to NAV. And his findings show that there is a strong correlation between the average hedge fund premium and the premium on the average US closed-end mutual fund - these funds are traded on major US stock exchanges.

Moreover, Dr Ramadorai believes that theories put forward about the mutual fund market - such as a predicted nonlinear relationship between past performance and transaction premiums - can be applied to the current hedge fund market:

Dr Ramadorai commented: "That we have the opportunity to use theories specifically formulated for the mutual fund market and apply them to the hedge fund market is highly significant," says Dr Ramadorai. "It will allow us to shed some light on the long standing debate about whether prices are determined by fluctuations in investor sentiment or market reasons like performance and liquidity. Sometimes, the study of a new market can help us solve old debates, and these findings may have a significant influence on the way we view both the hedge fund and mutual fund markets."

Dr Ramadorai's believes that the secondary market can be used as an indicator of what hedge fund investors are thinking when they enter and exit hedge funds. His research has looked at what factors influence an investor's decision to invest in a fund, and the price at which they are willing to trade.

The research pinpointed risk-adjusted performance and managerial incentives as two key concerns of hedge fund investors: "Good past performance or high levels of incentives translate into a higher price being paid to acquire the fund".

Conversely, the research has shown that high management fees and restrictions on withdrawals are factors that are likely to make investors seek a lower price for shares in hedge funds.