Grey matters

The ABCs of hedge funds: alphas, betas; costs.  Roger G. Ibbotson, Peng Chen, & Kevin X. Zhu
Available at



Despite the retrenchment of the hedge fund industry in 2008, hedge fund assets under management are currently over one and a half trillion dollars. We analyse the potential biases in reported hed

ge fund returns, in particular survivorship bias and backfill bias. We then decompose the returns into three components: the systematic market exposure (beta), the value added by hedge funds (alpha) and the hedge fund fees (costs). We analyse the performance of a universe of about 8,400 hedge funds from the TASS database from January 1995 through December 2009. Our results indicate that both survivorship and backfill biases are potentially serious problems.
Adjusting for these biases brings the net return from 14.26 per cent to 7.63 per cent for the equally weighted sample. Over the entire period, this return is slightly lower than the S&P 500 return of 8.04 per cent, but includes a statistically significant positive alpha. We estimate a pre-fee return of 11.42 per cent, which we split into a fee (3.78 per cent), an alpha (3.01 per cent), and a beta return (4.62 per cent).
The positive alpha is quite remarkable, since the mutual fund industry in aggregate does not produce alpha net of fees. The year by year results also show that alphas from hedge funds were positive during every year of the last decade, even through the recent financial crisis of 2008 and 2009.

CFR comment
The hedge fund industry’s dramatic growth from 1990 to 2009 – from 530 funds managing $50 billion to more than 8,000 funds managing $1.6 trillion – introduces some serious problems in analysing the industry. This paper examines data from 1995-2009 and correct for survivorship bias (eg the problem of studying only funds that continue, dropping data on funds that fail) and backfill bias (eg some funds’ practice of beginning to report data only after success).
Updating the foundational Stephen Brown, William Goetzmann, & Roger G. Ibbotson, Offshore Hedge Funds: Survival and Performance 1989-1995, Journal of Business, vol. 72, no. 1, pp. 91-117, from 1999 that studied funds from 1989-1995 and found statistically significant alphas for hedge funds, this work confirms the existence of statistically significant alphas but also shows that a substantial part of the return from funds is due to stock, bond and cash betas rather than alpha.
The paper also finds positive alphas for all years studied except 1998, suggesting that hedge fund managers add value in both bull and bear markets.

A random walk by fund of funds managers?  Frans A. De Roon, Jinqiang Guo and Jenke R. ter Horst.

Available at 

paper investigates whether hedge fund of funds managers invest in
single-strategy hedge funds in a random fashion. By examining the
underlying single-strategy hedge funds from which a fund of funds can
select, we find that single-strategy hedge funds added to the portfolio
of funds of funds display some distinct characteristics:

(1) they tend to be larger in size, have longer operational history and are more likely to operate as offshore hedge funds;
(2) they have higher incentive fees and are more likely to have a high watermark clause;

(3) they tend to have greater minimum initial investment requirements and a higher proportion of closed funds;

(4) their managers have more years of investment experience and

they have a much higher risk-adjusted return or ex post alpha, a lower
tracking error and a higher information ratio, in both the short run and
long run. More importantly, a probit analysis of fund inclusion
conforms the importance of several fund features and manager
characteristics mentioned above, with the ex post alpha and the tracking
error being the key factors to the inclusion decision.

addition, there is a convex relation between the probability of fund
inclusion and the minimum initial investment such that the probability
increases with the minimum initial investment at a decreasing rate.
Finally, the importance of those characteristics to the inclusion
decision varies by fund styles.

CFR comment
Are the
funds included in fund of funds systematically different from those not
included? If fund of funds managers are adding value, they should be.
This paper examines a large dataset of hedge fund data covering 15 years
and concludes they are. While this doesn’t answer the question of
whether fund of funds provide sufficient additional returns to justify
the extra layer of fees, funds professionals and regulators will find
this potentially useful in understanding fund of funds and for creating
benchmarks for fund of funds performance.

Comparing EU and US responses to the financial crisis.  Karel Lannoo ECMI Policy Brief No. 14 (Jan. 2010)

Available at  and 

2003, the EU and the US have conducted a vibrant regulatory dialogue on
financial regulation, but domestic priorities seem to have taken
precedence in response to the financial crisis. This paper compares the
institutional and regulatory changes occurring on both sides of the
Atlantic. On the institutional side, it compares macro- and
micro-prudential reforms. On the regulatory side, it compares four key
areas: bank capital requirements, reform of the OTC derivative markets
and the regulation of credit ratings agencies and hedge funds. It
concludes by highlighting certain implications for the regulatory
CFR comment

An excellent brief overview
of the contrasting responses of the US and EU to the financial crisis,
this six page paper provides a summary of the different approaches and
points out problems these differences are likely to cause in the future.


The New Zealand offshore trust regime.  John Prebble 

Available at 

New Zealand is in general a high tax country. It
is host to a thriving offshore trust industry established after an
amendment to the income tax legislation in 1987. The successor to this
amendment is section HC 26(1), which states that where non-residents
settle income-producing property on New Zealand resident trustees, New
Zealand does not tax the income in the hands of the trustees so long as
that income has a foreign source.
CFR comment
Zealand, which we generally think of as a high tax jurisdiction, has a
robust trust law that allows non-residents to establish offshore trusts
there and to avoid taxation. This short paper provides an overview of
the main features of NZ trust law. A useful read for those involved with
trusts and those looking for data points with which to skewer high tax
jurisdictions, like New Zealand, that complain about offshore

Impact of the financial crisis.  Reinout D. Vriesendorp & Martin
A. Gramatikov.  INSOL International (Jan. 2010)

Available at 

major thrust of insolvency reform across many jurisdictions over the
last twenty years has been the development of legislation to facilitate
business reorganisations. Any regime which involves rescue requires a
degree of support from the commercial environment. That is, the
continuation of a business in the shadow of insolvency will probably
require some additional funding and at the very least require existing
creditors to postpone and/or compromise their claims.

rescue regimes may therefore be severely tested in situations where
there is a general economic downturn such as the world has experienced
in the last two years. Somewhat paradoxically it can be that just when
rescue is needed the most, the practical reality may be that businesses
will not be saved if there is insufficient support available either by
way of additional credit or because other creditors are so financially
stressed themselves that they are unable or unwilling to support any
potential rescue.

This survey evaluates empirically the
perceived impact of the global financial crisis on the opportunities for
rescue. We did not come across any empirical research performed using
the aggregate know-how of the professionals involved in the rescue
business internationally. Therefore, INSOL decided to undertake a survey
of insolvency professionals across the world through its membership, in
collaboration with INSOL Academics Group. 562 insolvency professionals
from 56 jurisdictions worldwide (mostly from the UK, Australia, Canada,
Netherlands, USA, New Zealand, Hong Kong, South Africa, Germany and
India) responded to the survey.

The vast majority of the
interviewed insolvency professionals agree that the credit crisis of
2007 stifled the access of distressed business to financial facilities
so needed for successful restructuring. This accord holds across legal
systems, continents, countries or professional experience of the
respondents. The implication is clear: the financial crisis retrenched
the access to financial facilities and thus impacted negatively the
prospects for preventing or even ending the bankruptcy procedure with
reorganisation instead of winding up of the estate assets. Several
reasons have been pointed out by the insolvency professionals:

there is the objective decrease of cheap and liquid financial
resources. The traditional funders of distressed business – banks and
hedge funds – are in financial troubles themselves and apply more
selective and cautious risk management rules.

It has also been
recognised that the banks nowadays operate under more rigid public
policies and the political and public expectations are for prudency and

Financing of restructuring is objectively a source
of high risk and on the one hand, the insolvency representatives see in
their practices that the banks do not welcome this risk.

On the
other hand, the insolvency professionals also think that the banks are
overly risk aversive and eager to show constraint. Some of the
respondents even think that as the bankers failed to recognise the
symptoms of the credit crunch, they nowadays have become short-sighted
to recognise the long-term interests of their clients.

CFR comment
report of a survey of international insolvency specialists on the
impact of the financial crisis, this paper points out areas of
disagreement and agreement among the group.

A useful read for anyone looking to understand how bailouts are being implemented across jurisdictions.


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Andrew P. Morriss

Andrew P. Morriss, Chairman, is the D. Paul Jones, Jr. & Charlene Angelich Jones – Compass Bank Endowed Chair of Law at the University of Alabama School of Law. He was formerly the H. Ross & Helen Workman Professor of Law and Business at the University of Illinois,Urbana-Champaign. He received his A.B. from Princeton University, his J.D. and M.Pub.Aff. from the University of Texas at Austin, and his Ph.D. (Economics) from the Massachusetts Institute of Technology. He is a Research Fellow of the N.Y.U. Center for Labor and Employment Law,and a Senior Fellow of the Institute for Energy Research, Washington,D.C., as well as a regular visiting faculty memberat the Universidad Francisco Marroquín,Guatemala. He is the author or coauthor of more than 50 scholarly articles, books, and bookchapters, including Regulation by Litigation (Yale Univ. Press 2008) (with Bruce Yandle and Andrew Dorchak), and is the editor of Offshore Financial Centers and Regulatory Competition (American Enterprise Institute Press 2010).

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