Dieter G. Kaiser

Measuring Funds of Hedge Funds Performance Using Quantile Regressions: Do Experience and Size Matter?

This article is the first to use quantile regression to analyze the impact of experience and size of funds of hedge funds (FHFs) on performance. In comparison to OLS regression, quantile regression provides a more detailed picture of the influence of size and experience on FHF return patterns. Hence, it allows one to study the relevance of these factors for various return and risk levels instead of average return and risk, as is the case with OLS regression. Because FHF size and age (as a proxy for experience) are available in a panel setting, one can perform estimations in an unbalanced stacked panel framework. This study analyzes time series and descriptive variables of 649 FHFs drawn from the Lipper TASS Hedge Fund database for the time period January 1996 to August 2007. The empirical results suggest that experience and size have a negative effect on performance, with a positive curvature at the higher quantiles. At the lower quantiles, however, size has a positive effect with a negative curvature. Both factors show no significant effect at the median.

The Risk of Funds of Hedge Funds: An Empirical Analysis of the Maximum Drawdown

Funds of hedge funds (FHF) are perceived to be the premier choice for institutional investors looking to enter the alternative investment asset class. This article empirically investigates the maximum drawdowns of FHF. It analyzes the time series and descriptive variables of 649 FHFs from the Lipper TASS Hedge Fund database for January 1996 through August 2007. The empirical results suggest 1) the number and the magnitude of drawdowns decreases as the experience of the FHF increases, 2) the average recovery time is higher for older FHFs, 3) there is no difference between small and large FHFs in regards to the magnitude of a maximum drawdown, 4) the higher a maximum drawdown of a FHF, the longer it takes to recover, and 5) most maximum drawdowns occur during times of financial market turmoil. Thus, our findings question especially the acclaimed ability of FHFs to deliver absolute returns. We also show that the beta risks involved with FHFs are high. We find that the advantages of FHFs are more likely to be in their low long-term correlations with traditional asset classes, as well as in their low volatility.

The value-added of investable hedge fund indices

This article empirically investigates the risk and performance of three types of alternative beta products over the January 2002 to September 2009 time period: funds of hedge funds (FHFs), investable hedge fund indices (IHFIs), and hedge fund replication strategies (HFRS). The authors show that IHFIs are true alternative beta products with high correlations and beta to non-investable hedge fund indices. Their results further suggest that, in a best case scenario, IHFIs outperform FHFs and HFRS on a risk-adjusted basis. However, in the worst case scenario, IHFIs underperform both investments. If one takes the average of all IHFIs, one finds that they perform equally as well as FHFs. Hence, IHFIs constitute a solid alternative to FHF investments, while costing substantially less, and offering generally more transparency and liquidity. The authors propose that fee-sensitive investors especially should consider taking a core-satellite approach to their hedge fund portfolio, with the core represented by cheap passive hedge fund beta through IHFIs, and the satellite represented by more expensive and actively managed alpha-generating FHFs.

Venture Capital Financing from an Entrepreneur's Perspective

One option for entrepreneurs to finance and grow their companies is venture capital. After the boom and bust of the new economy, the venture capital industry has regained importance in financing innovative companies. This study contributes by providing a survey of the literature on the structural and behavioural aspects of venture capital financing from the entrepreneurs perspective. The aim of this survey is to organize and summarize existing theoretical and empirical work on venture capital financing with a view to making entrepreneurs aware of best practice for their interactions with venture capital companies. The authors conclude that entrepreneurs, before seeking venture capital finance, should consider this option carefully, as investors could pursue their own aims even if they are contradictory to those of the entrepreneur.

Hedging Equity Market Risk in Hedge Fund Investing: A New Approach

We argue that investors in funds of hedge funds underestimate the traditional equity market beta of these perceived absolute return investment vehicles. Hence, during times of financial crisis, when the correlations of most asset categories with each other increase dramatically, the traditional equity market beta can have an adverse effect on fund of funds performance. Because investors in such environments are rarely able to redeem their fund of fund holdings due to either a general low liquidity (e.g., notice and redemption periods or lock-ups), or extraordinary circumstances (e.g., maximum redemptions, gates, side-pockets), we posit that the only way to decrease unwanted exposure is through overlay strategies. The academic literature so far has focused on the multifactor approach to estimate equity exposure in hedge fund portfolios. We compare different hedging approaches: a pure value-at-risk (VaR)-based approach, a technical market risk signal approach, and a combination of both over the May 2004-September 2009 period using weekly data from an investable hedge fund index. Our results suggest that using a risk overlay system for funds of hedge funds decreases the downside risk of hedge fund investing significantly during economic crises.

The Need for Diversification and its Impact on the Syndication Probability of Venture Capital Investments

In recent years, the venture capital and private equity industries have witnessed significant growth in assets under management. Investors prefer investing in funds instead of single investments primarily for the diversification benefits and hence the need to determine whether growing fund volumes are beneficial for diversification is of significant importance. To examine this issue, this article uses a unique dataset that includes fully and partially realized investments portfolio companies worldwide. The results show that diversification benefits in this industry can be limited by transaction costs due to information asymmetries. Syndication is a common instrument that is used to overcome these limitations and achieve sufficient diversification, especially for smaller fund sizes. The results also show fund size and investment experience are negatively correlated with syndication probability, while early-stage investments and venture deals are positively correlated.

Dynamic Linkages between Hedge Funds and Traditional Financial Assets: Evidence from Emerging Markets

This paper analyses the short- and long-term relationships between hedge funds and traditional financial assets using multivariate cointegration analysis in order to investigate if the fees charged by hedge funds are justified for the kind of exposure they provide to investors. We therefore create an emerging market composite hedge fund index as well as region specific indices based upon a unique and large sample of 404 emerging market hedge funds obtained from the merger of two different databases. As to whether diversification benefits arise from adding emerging markets hedge funds to an emerging markets bond/equity portfolio, our results show that the advantages are significantly less for Eastern Europe than for the other emerging market regions of Asia and Latin America during the period January 1998 through May 2006. In summary, we find evidence that emerging market hedge funds in general are redundant securities for long-term investment horizons.

Efficient Hedge Fund Strategy Allocations – Systematic Framework for Investors that Incorporates Higher Moments

In this paper, we provide a realistic framework that investors can use to optimize hedge fund portfolio strategy allocations. Our approach includes important aspects that investors need to address in the real world, such as how limited resources can restrict the ability to conduct multiple due diligences. Additionally, our approach is not based on a utility function, but on an easily quantifiable preference parameter, lambda. We need to account for higher moments of the return distribution within our optimization and approximate a best‐fit distribution. Thus we replace the empirical return distributions, which are often skewed or exhibit excess kurtosis, with two normal distributions. We then use the estimated return distributions in the strategy optimization. Our dataset comes from the Lipper TASS Hedge Fund Database and covers the June 1996‐December 2008 time period. Our results show in‐ and out‐of‐sample that our framework yields superior results to the Markowitz framework. It is also better able to manage regime switches, which tend to occur frequently during crises. Lastly, to test our results for stability, we use robustness tests, which allow for the time‐varying correlation structures of the strategies.

Strategic Hedge Fund Portfolio Construction that Incorporates Higher Moments

In this paper we optimize a hedge fund portfolio considering higher moments of the different hedge fund strategy return distributions. We replace the empirical return distributions which are often skewed or exhibit excess-kurtosis with two normal distributions to approximate a best-fit distribution. This procedure is known as the mixture of normal method and is widely used in financial applications. We then use the estimated return distributions in the strategy optimization. Further we incorporate that institutional investors and in particular fund of hedge fund managers seek an optimal allocation of resources and therefore only execute a limited number of due diligence processes. Furthermore real investors preferences are con-sidered in optimization procedure. In order to test our results for stability we use robustness tests which allow for the time-varying correlation structures of the strategies.

Total Loss Risk in European versus US-based Venture Capital Investments

This chapter provides evidence that there are systematic differences regarding the total loss risk for European and U.S.-American venture capital (VC) and private equity investments. It measures the risk of total losses for a set of investments twofold, namely, the probability of one failure to the total number of investments in a given fund portfolio, and the fraction of capital lost in one failure to the total capital injected in all deals of a fund portfolio, which is termed as the total-loss–capital ratio. It uses a unique dataset and analyzes 1011 matched private equity and VC investments in Europe and the U.S. during the period of 1979 through 2003 in regards to total losses. This dataset is used to test three hypotheses in detail concentrating on the investment experience of the fund management, syndication of a stake with other investors, and the focus of the investor on venture capital. After analyzing the total dataset for these hypotheses, the commonalities as well as differences in regards to total losses for U.S.- versus European-based deals are investigated. The results show that more experienced European investment firms prefer a lower probability of failure at the expense of a higher total-loss–capital ratio. The more experienced European firms, because of their cultural differences, are more focused on the avoidance of a failure than on the amount of capital lost.