Grey matters

The first two papers we discuss introduce an economic geography perspective on offshore issues. Lawyers and financial industry professionals may be unfamiliar with this academic discipline, so these offer some insights into the growing literature on OFCs.


Deconstructing Offshore Finance

Gordon L. Clark, Karen P. Y. Lai, & Dariusz Wojcik

ECONOMIC GEOGRAPHY 91(3): 237-249 (2015), available at

Recent scandals involving large corporations including Amazon, Apple, Google, Starbucks and HSBC have highlighted the problems of tax avoidance, evasion and offshore financial activities. Considering their significance to growing inequality and financial instability, renewed media and public attention is well justified, and new research on these topics urgent. At the same time, however, there is confusion in the very use of the term offshore finance. Some apply it interchangeably with tax havens, others go as far as to use it as a synonym of international finance. The authors argue that offshore finance needs a precise definition, and careful positioning in a broader economic geographical framework. They suggest a definition based on the legal and accounting in addition to financial aspects of offshore, and propose the concept of Global Financial Networks to situate offshore jurisdictions and offshore finance in the firm-territory nexus, and in relation to Global Production Networks. This sets the stage for three research papers presented in this issue, which map offshore financial networks at global and regional scales, and investigate its causes and mechanisms.

CFR Comment:
This introduction to a special section of the journal Economic Geography on offshore financial centers is worth reading as an introduction to how the discipline of economic geography is approaching international finance. As the authors note, many of the most cited papers on offshore topics come from this discipline, so paying attention to what economic geographers have to say is useful.


Financial Geography

Karen P.Y. Lai

In N. Castree, M. Goodchild, W. Liu, A. Kobayashi, R. Marston, and D. Richardson (eds.), THE WILEY-AAG INTERNATIONAL ENCYCLOPEDIA OF GEOGRAPHY: PEOPLE, THE EARTH, ENVIRONMENT, AND TECHNOLOGY (2017), available at

Financial geography is concerned with the roles of finance, money and markets in the restructuring of contemporary capitalism, how these changes have uneven impacts across space. Studies focus on the ways in which space and place are mobilized in shaping financial decisions, allocation of capital, regulatory frameworks of global financial markets, and development of onshore and offshore financial centers. An early political economy approach to regulation of international financial markets is later complemented by more social and cultural explanations and network approaches for analyzing the persistence and increasing importance of international financial centers (IFCs) as strategic basing points for global capital. Scales of analyses range from global frameworks and national financial markets to industry processes and household behavior. While much of the financial geography literature has concentrated on Anglo-American economies, recent research highlights the increasing significance of emerging economies and alternative financial networks such as sovereign wealth funds and Islamic finance.

CFR Comment:
A broad introduction to how economic geographers think about money, this is a useful way to understand this growing literature that has the ability to shape how regulators think about OFCs.


Turning from macro level issues to micro level ones, some recent papers examine hedge funds from a variety of perspectives. We start with three papers that look at which funds perform best in different circumstances, with some surprising issues, starting with what sort of car the investment manager drives.


Sensation Seeking, Sports Cars, and Hedge Funds

Stephen Brown, Yan Lu, Sugata Ray, & Melvyn Teo

This paper finds that hedge fund managers who own powerful sports cars take on more investment risk. Conversely, managers who own practical but unexciting cars take on less investment risk. The incremental risk taking by performance car buyers does not translate to higher returns. Consequently, they deliver lower Sharpe ratios than do car buyers who eschew performance. In addition, performance car owners are more likely to terminate their funds, engage in fraudulent behavior, load up on non-index stocks, exhibit lower R-squareds with respect to systematic factors, and succumb to overconfidence. The paper considers several alternative explanations and conclude that manager revealed preference in the automobile market captures the personality trait of sensation seeking, which in turn drives manager behavior in the investment arena.

CFR Comment:
This clever paper uses data on sports car ownership by hedge fund managers to find a 16.61 percent increase in volatility in funds managed by the car owners – without greater returns. The paper explores why this occurs, finding more frequent trades and greater risks. It uses data on over 1,100 fund managers and data on vehicles collected by the authors.


Hedge Fund Activists’ Network and Information Flows

Pouyan Foroughi

(April 30, 2016), available at

This paper studies connections and information flows between activist hedge funds and other institutional investors and shows them as prominent factors in the success of activist campaigns. Using manager turnovers in connected mutual funds as exogenous shocks to activist funds’ connectivity, the author identifies a positive causal effect of connections with other investors on the short-run and long-run performance of activists’ campaigns and campaign characteristics. Furthermore, the analysis provides evidence that the two likely mechanisms through which activists benefit from their relationships with other institutional investors are information flows between institutional shareholders and well-connected activists before campaign announcements and higher support from other shareholders during the campaign. Overall, these results highlight that connections to other institutional investors benefit institutional asset managers.

CFR Comment:
How information moves affects fund performance, since – besides not having your fund manager drive a sports car – a key to getting good results is access to information. This paper creatively explores the connections through which information flows, suggesting another dimension upon which to evaluate fund managers.


The Pitfalls of Going Public: New Evidence from Hedge Funds

Lin Sun & Melvyn Teo

(December 10, 2016) available at

Hedge funds managed by listed firms significantly underperform funds managed by unlisted firms. The authors argue that since the new shareholders of a listed management company typically do not invest alongside the limited partners of the funds managed, the process of going public breaks the incentive alignment between ownership, control, and investment capital, thereby engendering agency problems. In line with the agency explanation, the underperformance is more severe for funds that have low manager total deltas, low governance scores, and no manager personal capital, or that are managed by firms whose stock prices are more sensitive to earnings news. Post IPO, listed firms aggressively raise capital by launching multiple new funds. Consequently, despite the underperformance, listed firms harvest greater fee revenues than do comparable unlisted firms. Investors continue to subscribe to hedge funds managed by listed firms as they appear to offer lower operational risk.

CFR Comment:
Once you’ve checked out your fund manager’s choice of car and confirmed their connections, this paper suggests that whether or not the fund manager is public or not makes a difference, focusing on the incentive effects of manager investments in the fund.


Presidential Elections, Political Sensitivity, and Hedge Fund Performance

Honghui Chen, Alok Kumar, Yan Lu, & Ajai K. Singh

(November 16, 2016) available at

The authors develop and test a hypothesis that hedge fund managers who respond to and capitalize on the changing political environment around presidential elections are better skilled. They find that hedge funds, on average, trade in anticipation of the presidential election outcome, and adjust the political sensitivity of their portfolio accordingly. Managers who adjust their portfolio political sensitivity most successfully generate significantly higher alpha than those that are least successful in their adjustments. The significant superior performance by these funds persists for about a year. They also find that these funds are more likely to survive over the following two years. Their evidence suggests that hedge funds’ anticipation and response to presidential elections indicate managerial skill and can successfully predict future fund performance.

CFR Comment:
The authors’ show that funds with managers with better political sensitivity outperform those who fail to adjust to anticipated election returns. (An updated study with post-U.K. referendum and U.S. presidential election data would be most welcome.) Applying a clever methodology previously published by one of the authors to index political sensitivity of portfolios (itself worth a read), the authors develop an equally clever means of estimating the extent to which managers make politically sensitive adjustments to fund portfolios in advance of U.S. presidential elections. Technical but worth a read.


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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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