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Sifting through the Wreckage: Lessons from Recent Hedge-Fund Liquidations

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In this paper, the authors compare the characteristics of liquidated hedge funds with surviving hedge funds and propose some rules for the SEC to gather more information on hedge funds. They base their analysis on the TASS Hedge Fund database which contains a live database of existing hedge funds (2,771 funds) and a Graveyard database for funds no longer in existence (1,765 funds), from 1994 to 2004.  The TASS database covers 11 investment styles: 
  1. Convertible arbitrage
  2. Dedicated short seller
  3. Emerging markets
  4. Equity market neutral
  5. Event driven
  6. Fixed-income arbitrage
  7. Global macro
  8. Long-short equity
  9. Managed futures
  10. Multi-strategy
  11. Fund of funds
 The most represented styles are long-short equity (31%), fund of funds (21%), managed futures (11%) and event driven (8%). Interestingly, they do not focus only on liquidated but on all hedge funds that have stopped reporting into the live database. This means that funds, which have closed to new investors, might also be included. There are seven status categories for funds in the database (Table 2) 
  1. Fund liquidated
  2. Fund no longer reporting to TASS
  3. TASS cannot contact the manager
  4. Fund closed to new investment
  5. Fund has merged with another entity
  6. Fund dormant
  7.  Unknown
 They “argue that using the entire Graveyard database may be more informative”, because their “purpose is to develop a broader perspective on the dynamics of the hedge fund industry”. We however do not find this reason convincing. From the Live and the Graveyard databases, they document that:
  • Graveyard hedge funds have higher volatility, often lower annual returns but not always compared with the Live hedge funds (returns are net of fees). 
  • Live funds have more serial correlation than Graveyard funds
  • The median age of the Graveyard funds is a bit less than 4 years
  • The median size of the Graveyard fund is $6.3 million.
  • The average attrition rate (ratio of exiting funds in a given year on the total number of funds at the beginning of the year) for the full database is 8.8%
  • Attrition rate is higher for managed futures (14.4%), global macro (12.6%) and fixed-income arbitrage (10.6%)
  • Attrition rate is lower for convertible arbitrage (5.2%), event driven (5.4%) and fund of funds (6.9%) 

In the rest of their article, they discuss the liquidity of hedge fund investments. They use the autocorrelation of the returns as a proxy for illiquidity. 

They also suggest the construction of a “Capital Markets Safety Board” similar in spirit to the National Transportation Safety Board (NTSB) which is “an independent U.S. Federal agency that investigates every civil aviation accident in the United States and significant accidents in the other modes of transportation, conducts special investigations and safety studies, and issues safety recommendations to prevent future accidents.”  The “Capital Markets Safety Board” would investigate and collect data on hedge fund crashes.   

Getmansky, Mila, Lo, Andrew W. and Mei, Shauna X., "Sifting through the Wreckage: Lessons from Recent Hedge-Fund Liquidations" . Journal of Investment Management, 4th Quarter, 2004 Available at SSRN: http://ssrn.com

 

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