Reconsidering Funds of Hedge Funds

How will the funds of hedge funds (FoHF) business have to change to survive in the wake of the 2008-2012 financial crisis? This new research provides valuable insight. Reconsidering Funds of Hedge Funds presents the first comprehensive views of UCITS as well as recent trends in due diligence, risk management, and hedge fund deaths and survivors. The book contains original chapters by 22 academics and 16 hedge fund professionals, and includes two sections on performance: one that looks at UCITS FoHF and one that deals with traditional FoHF performance. Most chapters examine aspects of the 2008-2012 financial crisis, and almost every chapter addresses fund of hedge funds' management process before, during, and after the crisis.

• Covers recent advances in risk management, due diligence, tail risk, and allocation
• Presents an in-depth analysis of UCITs
• Balances academic and professional viewpoints

Upper-division undergraduates, graduate students, and professors studying financial risk management, investments, and investment market trends.  Financial industry professionals working on both the buy- and sell-sides of investment firms

Foreword

Editor

Contributors

Acknowledgments

Introduction

Section 1 Due Diligence and Risk Management

Section 2 UCITS Performance

Section 3 Performance

Section 4 Fund of Hedge Fund Alpha

Section 5 Tail Risk

Section 6 Regulation

Chapter 1. After the Crisis: The Withering of the Funds of Hedge Funds Business?

1.1 Introduction

1.2 Institutional versus Private Investor FoHFs

1.3 The Bubble Bursts

1.4 The Aftermath of Crisis

1.5 The Excess Cash Problem

1.6 Could FoHFs Problems Have Been Prevented?

1.7 The Role of Performance Decay

1.8 Outlook

Conclusion

References

Section 1: Due Diligence and Risk Management

Chapter 2. Evaluating Trends in Funds of Hedge Funds Operational Due Diligence

2.1 Introduction

2.2 Increased Focus on Operational Due Diligence

2.3 Chapter Goals

2.4 What is Operational Risk?

2.5 The Different Types of Operational Risk

2.6 Operational Risk in a FoHFs Context

2.7 FoHFs Operational Due Diligence Frameworks

2.8 The Madoff Effect

2.9 Deep-Dive Operational Due Diligence

2.10 Broadening Scope Reviews and Declining Checklist Approaches

2.11 The Increasing Role of Operational Due Diligence Consultants

Conclusion

References

Chapter 3. The Limits of UCITS for Funds of Hedge Funds

3.1 Introduction

3.2 The UCITS Industry

3.3 Challenges for a UCITS FoHFs Manager

3.4 Performances

Conclusion

Acknowledgments

References

Recommended Reading

Chapter 4. Due Diligence: Lessons from the Global Financial Crisis for Funds of Hedge Funds with Particular Emphasis on the Asia–Pacific Region

4.1 Introduction

4.2 Due Diligence when Investing in a Hedge Fund

4.3 Investment in a FoHF and Due Diligence

4.4 Asia–Pacific Hedge Fund and FoHFs Growth and Performance

4.5 Before the GFC

4.6 Collapse: 2008

4.7 After the Storm

4.8 The Requirements of Due Diligence in a Post-GFC Environment

Conclusion

Acknowledgments

References

Chapter 5. The Use of Managed Accounts by Funds of Hedge Funds

5.1 Adversities of Funds of Hedge Funds in 2008

5.2 MAC Structures for FoHFs

5.3 Hypotheses, Advantages, and Disadvantages of MACs

5.4 Survey

5.5 Summary

Conclusion

Acknowledgments

References

Chapter 6. Choice of Risk Measure in Evaluating UCITS Funds of Hedge Funds

6.1 Introduction

6.2 Literature Review

6.3 Empirical Analysis

Conclusion

Acknowledgments

References

Section 2: UCITS Performance

Chapter 7. UCITS Funds of Hedge Funds – The New Panacea?

7.1 Introduction

7.2 Fund Structures

7.3 Investment Managers

7.4 Funds Liquidity and Fees

7.5 Return and Risk Analysis

Conclusion

Acknowledgments

References

Chapter 8. The Return Potential of UCITS Funds of Hedge Funds: An Analysis of their Investment Universe

8.1 Introduction

8.2 Descriptive Comparison of the UCITS versus the Offshore Hedge Fund Universe

8.3 Performance Comparison of Simulated UCITS FoHFs versus Offshore FoHFs Portfolios

Conclusion

References

Chapter 9. How Geography, Flows, and Size Affect the Risk-Adjusted Performance of UCITS III Funds of Hedge Funds

9.1 Introduction

9.2 Literature Review

9.3 Data

9.4 Performance of and Flows into UCITS FoHFs

9.5 Risk Analysis

Conclusion

Acknowledgments

References

Chapter 10. Funds of Hedge Funds versus Do-It-Yourself Funds of UCITS

10.1 Introduction

10.2 Issues with Hedge Fund Investing – The Case of FoHFs

10.3 Testing for Non-Linearities in Hedge Fund Returns – A New Approach

10.4 UCITS-Compliant Hedge Funds as a Fit for FoHFs Construction

10.5 Regulatory Risks Around UCITS Hedge Funds

Conclusion

Acknowledgments

References

Section 3: Performance

Chapter 11. Predicting Funds of Hedge Funds Attrition Through Performance Diagnostics

11.1 Introduction

11.2 Data and Variable Construction

11.3 The Treatment of Performance Measures

11.4 Linking Fund Performance to Subsequent Attrition

Conclusion

References

Appendix

Chapter 12. Does Funds of Hedge Funds Size Matter? Size versus Performance Before, During, and After the Crisis

12.1 Backdrop

12.2 FoHFs Post the 2008 Financial Crisis

12.3 Performance

Conclusion

Acknowledgments

References

Chapter 13. Normalized Risk-Adjusted Performance Measures Revisited: The Performance of Funds of Hedge Funds Before and After the Crisis

13.1 Introduction

13.2 Theoretical Framework

13.3 Data and Empirical Method

Conclusion

References

Chapter 14. The Impact of the 2008 Financial Crisis on Funds of Hedge Funds

14.1 Introduction

14.2 Data and Sample Statistics

14.3 Changes in AUM During the 2008 Financial Crisis

14.4 Asset Size and FOHFS Performance During the 2008 Financial Crisis

14.5 Diversification and FoHFs Performance During the 2008 Financial Crisis

14.6 Risk Factor Estimates of FoHFs Pre- and Post-2008 Financial Crisis

14.7 Attrition Rates and FoHFs Survival Analysis

Conclusion

References

Chapter 15. Forecasting Funds of Hedge Funds Performance: A Markov Regime-Switching Approach

15.1 Introduction

15.2 Data

15.3 Forecasting Models

15.4 Results

Conclusion

Appendix

References

Chapter 16. A Panel-Based Quantile Regression Analysis of Funds of Hedge Funds

16.1 Introduction

16.2 Panel Data Analysis and Quantile Regression

16.3 Data and Methodology

16.4 Discussion of the Results

Conclusion

Acknowledgments

References

Section 4: Fund of Hedge Fund Alpha

Chapter 17. Reward-to-Risk Ratios of Funds of Hedge Funds

17.1 Introduction

17.2 Methodology

17.3 Data and Descriptive Statistics

17.4 Empirical Results

Conclusion

References

Chapter 18. The Short-Run Performance Persistence in Funds of Hedge Funds

18.1 Introduction

18.2 Data

18.3 Time Variation in FoHFs Risk Exposure

18.4 Time Variation in Performance

18.5 Back-Test on Short-Run Performance Persistence

Conclusion

Acknowledgments

References

Chapter 19. ‘Seeking Alpha’: The Performance of Funds of Hedge Funds

19.1 Introduction

19.2 Theoretical Approaches to Model Hedge Fund Returns

19.3 Regression Analysis

19.4 Results

Conclusion

Annex

References

Chapter 20. Quantitative Insight into Management of Funds of Hedge Funds and Consequences on Fund Alpha Performance

20.1 Introduction

20.2 Principal Components Analysis

20.3 Data and the Nature of the First Two Principal Components

20.4 Classification and Alpha Performance Evaluation in the Recent Financial Crisis

20.5 The ‘Pro-Active’ Nature of FoHFs

20.6 The Story of the Financial Crisis of 2008–2009 and Subsequent Developments

Conclusion

Acknowledgments

References

Chapter 21. Selecting Top Funds of Hedge Funds Based on Alpha and Other Performance Measures

21.1 Introduction and Literature Review

21.2 Impact of the Subprime Crisis

21.3 Performance Metrics

21.4 Summary Statistics of FoHFs Before and After the Subprime Crisis

21.5 How Does One Select ‘Elite’ FoHFs?

21.6 Identified FoHFs Managers with Genuine Skill

21.7 Out-of-Sample Performance of In-Sample ‘Elite’ FoHFs Funds

Conclusion

Acknowledgments

References

Chapter 22. Funds of Hedge Funds Strategies and Implications for Asset Management: Is Diversification Enough?

22.1 Introduction and Literature Review

22.2 Data

22.3 Factor Model (Risk Factors)

22.4 Portfolio Allocation with Hedge Funds and FoHFs

22.5 Certainty Equivalence and Portfolio Allocation with FoHFs

Conclusion

References

Section 5: Tail Risk

Chapter 23. The Intertemporal Relation between Tail Risk and Funds of Hedge Funds Returns

23.1 Introduction

23.2 Data and Methodology

23.3 Empirical Results

Conclusion

References

Chapter 24. Tail Risk Protection for Funds of Hedge Funds

24.1 Introduction

24.2 VIX, VIX Futures, VIX Options, and the VVIX

24.3 Tail Risk Hedging

24.4 Tail Risk Protection for FoHFs

Conclusion

References

Chapter 25. Autocorrelation, Bias, and Fat Tails: An Analysis of Funds of Hedge Funds

25.1 Introduction

25.2 Data and Strategies

25.3 Classical Performance Measurement

25.4 Problems of Classic Performance Measurement

25.5 Integrating the Problems in Performance Measurement

25.6 Adjusted Hedge Fund Performance Measurement

25.7 Analysis of Subperiods (Pre-Crisis and Post-Crisis)

Conclusion

References

Chapter 26. Crises and Funds of Hedge Funds Tail Risk

26.1 Introduction

26.2 Methodology

26.3 Empirical Results

Conclusion

References

Chapter 27. Funds of Hedge Funds, Efficient Portfolios, and Investor Clienteles: Empirical Evidence from Growth and Financial Crisis Periods

27.1 Introduction

27.2 Literature Review

27.3 Data

27.4 Methodology

27.5 Empirical Results

Conclusion

References

Section 6: Regulation

Chapter 28. Regulation: Threat or Opportunity for the Funds of Hedge Funds Industry?

28.1 Introduction

28.2 FoHFs and Solvency II

28.3 Fine-Tuning Solvency II Standard Formula

28.4 An Application to FoHFs

Conclusion

References

Chapter 29. Funds of Hedge Funds and the Principles of Fiduciary Investing Following the Global Financial Crisis

29.1 Introduction

29.2 The Principles of Fiduciary Investing

29.3 Prudent Investing

29.4 Investing in FoHFs

Conclusion

Acknowledgments

References

Chapter 30. Understanding the Regulation Impact: US Funds of Hedge Funds After the Crisis

30.1 Introduction

30.2 The Regulatory and Intervention Debate: Looking to the Economists

30.3 Lessons From Other Industries

30.4 The Road to Dodd–Frank

30.5 Dodd–Frank

30.6 US Funds and the AIFM Directive

30.7 FoHFs Trends During and After the GFC

Conclusion

Acknowledgments

References

Chapter 31. Canada and Australia: Do They Provide a Regulatory Model for Funds of Hedge Funds?

31.1 Introduction

31.2 FoHFs Statistical Comparisons Between Australia and Canada

31.3 FoHFs Regulation

Conclusion

Acknowledgments

References

Chapter 32. South African Regulatory Reforms of Funds of Hedge Funds

32.1 Introduction

32.2 The Investment Climate in South Africa

32.3 FoHFs in South Africa

32.4 Key Considerations for Investors in South African FoHFs

32.5 Regulation Impacting on South African FoHFs

Conclusion

Acknowledgments

References

Index