HFR and HFN database

Single manager hedge funds reporting to professional database vendors such as HFR and HFN are classified according to their self-reported investment strategy. However, strategic classifications of hedge funds are not consistent across database providers and style attribution of individual funds within databases may depend on a number of factors such as the predominant trading strategy, geographic or sector focus, financial gearing and hedge overlay, or type of investment instruments employed. It is questionable whether self-classification yields homogenous groups of funds representative of a distinct investment style and focus. In times of financial turmoil such as the subprime lending crisis in 2007, hedge fund managers were often found to gradually shift a fund’s investment focus away from its stated investment objective, either due to tightening liquidity or due to the devaluation of asset-based securities such as collateralised debt obligations (see section 3.4.1 on style shifts).

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To give an idea of the complexity surrounding hedge fund strategies and style classification, two figures have been included depicting the classification of hedge funds in the HFR and HFN database (Figure 5.1 and Figure 5.2). For visual purposes, a distinction is made between market directional and market neutral funds. It should be noted, however, that not all hedge funds belonging to the various sub-categories are easily defined as strictly directional or market neutral. HFR includes 31 different sub- strategies and differentiates between four major classifications (macro, equity hedge, event driven and relative value). HFN, on the other hand, makes provisions for 28 single manager strategies. In addition, HFR has four FoHFs and HFN three FoHFs strategies. Within HFN, the 28 sub-strategies are referred to as main strategies. No further information is given with respect to a broader classification. These classifications for HFN are provided by the author to facilitate the comparison of the two databases.

It should be apparent that, whilst impossible to cater for all sub-strategies depicted, hedge funds may be classified according to four broad strategic themes as defined in the HFR database: Equity Hedge, Event Driven, Macro and Relative Value. The sub- strategies of the HFN database were sub-classified according to the same HFR themes: Equity and Equity Market Neutral were joined to form the equity hedge category, Fixed Income strategies were subsumed under relative value, CTA/managed futures remained as a separate classification and all multi-strategy, option strategies and short- term trading funds were attributed to the newly formed classification ‘other’. The remaining classifications event driven and (Global) macro remained as they are. The appendix gives brief explanations for the more common investment strategies in hedge funds (Table A.2).

Results for the VEC models in section 7.6 were reproduced using commercial indices from the HFR and HFN database. The HFN database provides several classification indices based on investment philosophy as well as sector focus. Thirteen index series were selected that best correspond to the distinct classifications as identified in Chapter 6. For HFR, the HFRX index series was chosen (all series are included with the exception of the composite equal weighted index). Their composition is based on correlation and cluster analysis, and hence, the index construction philosophy is similar

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to index composition outlined in sub-section 6.3. There are also similarities in terms of number of constituents included and the weighting of constituents to maximise the correlation within strategic groups.13

13

For more information on HFRX indices: https://www.hedgefundresearch.com/?fuse=hfrx- faq&1254841202.

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Figure 5.1: Hedge fund classifications in the HFR database

Source: https://www.hedgefundresearch.com/index.php?fuse=indices-str&1291127795 Strategic

Classification

Directional Market

Neutral

Event Driven Relative Value Equity Hedge Macro FoHFs Currency Multi-Strategy Discretionary Thematic Commodity Systematic Diversified Active Trading Multi-Strategy Yield Alternatives Multi-Strategy Fixed Income Volatility Special Situations Merger Arbitrage Credit Arbitrage Regulation D Distressed / Restructuring Activist Multi-Strategy Equity Hedge Equity Market Neutral Sector Fundamental Growth Fundamental Value Short Bias Agriculture Energy Metals Multi Discretionary Systematic Asset Backed Convertible Arbitrage Corporate Sovereign Energy Infrastructure Real Estate Stellenbosch University http://scholar.sun.ac.za

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Figure 5.2: Hedge fund classifications in the HFN database

Source: https://www.evestment.com/resources/indices/fund-classification-guide Strategic

Classification

Directional FoHFs _NeutralMarket

CTA/managed futures

Global Macro Equity Fixed Income Event Driven Relative _Value

Mortgages Fixed Income (non- arbitrage) Macro Emerging Markets Other Event Driven Distressed Regulation D Merger/Risk Arbitrage Special Situations Fixed Income Arbitrage Capital Structure Arbitrage Statistical Arbitrage Asset Based Lending Convertible Arbitrage Other Arbitrage Long/Short Equity Dedicated Short Bias Sector Long Only Country Specific Small / Micro Cap Value Energy Finance Healthcare Technology Multi-Strategy Options Strategy Short-term Trading Equity Equity Neutral Market Stellenbosch University http://scholar.sun.ac.za

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5.3 Sampling

The information extracted from the two databases included the monthly return on investment (ROI), main investment strategy and sub-strategy. For hedge funds reporting to the HFR graveyard database, the date that the fund stopped reporting to the database was included. For both databases, ROI has been defined as change in net asset value during the month, assuming the reinvestment of any inflows on the fund’s reinvestment date, divided by net asset value at the beginning of the month. In general, returns were reported net of management fees, incentive fees or other expenditures. Net-of-fee performance was calculated and provided by the fund managers. Reported returns were assumed to be an accurate representation of investors’ realised returns. The sampling criteria comprised the following:

1. Single-manager funds only

2. Continuous track records of 123 return observations; no inconsistencies or performance gaps

3. USD as returns currency

4. At least monthly reporting frequency 5. Reporting style: net-of-all-fees.

Double-reporting funds within as well as between databases were accounted for. For example, hedge funds reporting to a database may elect to include time series for onshore and offshore investment vehicles separately. While the after-tax return may differ with respect to investor residency, the ROI reported to the database is identical for both onshore and offshore funds. Additionally, some managers offer several classes of the same basic investment strategy that differ with respect to the underlying currency (e.g. USD, EUR or GBP). To avoid accounting twice for the same investment fund, the analysis was limited to funds reporting in USD.This is on par with Amenc, Martellini and Vaissié (2003a): in order to avoid currency fluctuations, they included funds reporting in USD only. Since most hedge funds have a USD version, focusing on USD-denominated funds helps to avoid errors from duplicated funds.

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Lastly, a fund manager may offer several classes of the same basic investment strategy (e.g. market neutral) but that differ with respect to hedge overlay and leverage. Alternatively, similar series of the same funds may be offered as different share classes for regulatory and accounting reasons. Where these funds produced identical time series, one of the two series was eliminated. In the source SQL database, hedge funds reporting to HFR and HFN were compared on the basis of their coefficients of cross- correlations as well as the degree of similarity of the text strings for fund and manager name. If there were sufficient indications that two series are representative of the same underlying fund, one of the two series was removed. In the event where funds were found to report both to HFR and HFN, the HFN series was removed.

In the combined sample, if funds were found to report to both databases, only one of two records was retained. The HFR database was used as the primary database, and the samples were complemented with hedge funds reporting only to the HFN database. In the event where duplicate hedge funds belong to different strategy classifications in the HFR and HFN databases, the record was removed from the HFN classification. This could have led to fewer funds of that particular strategy entering the joint sample. The combined database of HFR and HFN includes 26 300 funds, of which 18 471 are single manager funds. Between April 1995 and June 2010, after accounting for double reporters, 1 055 funds provided a continuous performance track record of = 123 whilst fulfilling the sampling criteria outlined above (three funds were removed due to inconsistencies in their track record). An extensive list of the asset-based factors used in found below.

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Table 5.1: Regressors and data sources

Regressor Source

[ ] Price change in Gold quoted in USD (London PM Fix)

http://www.gold.org/assets/file/value/stats/statistics/xls/monthly_prices.xls

[ ] S&P Goldman Sachs Commodity Total Return Index

Bloomberg (Ticker: SPGSCITR Index)

[ ] Barclays Aggregate Bond Index

Bloomberg (Ticker: BABIDX Index)

[ ], [MSCIUS], [MSCIEXUS] USD

returns on Morgan Stanley Capital International Emerging Markets Index, MSCI World Index and MSCI World Index excluding USA

Bloomberg (Ticker: MXEF, MXWO and MXWOU Index)

[ ] Federal Reserve Traded Weighted Index of the US Dollar against Major Currencies

http://www.federalreserve.gov/releases/h10/Summary/indexb_m.txt.

[ ] Chicago Board Options Exchange Volatility Index

www.cboe.com/VIX

[ ], [ ], [ ] Returns on the SMB, HML, WML portfolios

SMB and HML:

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constructed from US equities http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/ftp/6_Portfolios_2x3.zip

WML:

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/ftp/F- F_Momentum_Factor.zip

[ 10 3 ], [ 10 ], [ 10 ] Yield curve spreads: Between 10-year Treasury Bill and 3-month Treasury, between Moody's yield on seasoned corporate bonds – all industries – Baa and 10-year Treasury Bill , and

between the contract rate on 30-year, fixed-rate conventional home

mortgage commitments (US) and 10- year Treasury Bill

http://www.federalreserve.gov/releases/h15/data/Monthly/H15_TCMNOM_Y10.txt http://www.federalreserve.gov/releases/h15/data/Monthly/H15_TCMNOM_M3.txt http://www.federalreserve.gov/releases/h15/data/Monthly/H15_BAA_NA.txt http://www.federalreserve.gov/releases/h15/data/Monthly/H15_MORTG_NA.txt [ ], [ ], [ ]. [ ], [ ] PTFS: Bond

look-back straddle, currency look- back straddle, commodity look-back straddle, short-term interest look-back straddle, and stock index look-back straddle

http://faculty.fuqua.duke.edu/~dah7/DataLibrary/TF-Fac.xls

All regressors are considered up to the third lag. Regressors are entered into the model if they improve upon the explanatory power and are not highly correlated to any other regressors or combinations thereof.

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