Introduction
In this research study on hedge funds by Eling and Faust (2010) the author’s sets out to compare the activeness of mutual and hedge funds in developing nations through analysis of data from each hedge fund. The paper major aim was to generate more knowledge to fill the missing gap in the current literature in the field of mutual funds and hedge funds performance in developing countries by assessment of available data on the same. The researchers used the latest innovations discussed in the current literature of performance measurements to analyze the emerging nation’s hedge funds performance. During the study the authors utilized the six-factor models, several of which represented latest innovations in this field such as CAPM, Fama and French among others (Eling and Faust, 2010).
In researching the objective for this paper the study utilized a sample size of “566 hedge funds and 1542 mutual fund of developing countries between the period, 1995 and 2008” which is necessary to compare the performance of each in these countries (Eling and Faust, 2010).
Literature review: Hedge funds
“Hedge fund” is a term that was introduced first in US by Albert Winslow Jones in the year 1949; ever since the industry of hedge funds has undergone a remarkable growth in figures as well as assets (Bali, Brown and Caglayan, 2011). In the last one decade the US has been leading on much of the current generated research on hedge funds, particularly the risk-return features and performance.
Fung and Hsieh (1997) were the earliest researchers to evaluate the performance of hedge funds in US and were able to establish that returns from mutual funds are highly correlated to returns on standard assets, whilst the hedge funds hold the opposite. Additionally, they were able to determine that hedge funds have higher performance than mutual funds; finally, they also established that varying forms of hedge funds generated disparities in performance while survivorship bias mainly affected returns of hedge funds measurements (Fung and Hsieh, 1997). It is from these early findings that researchers were able to conclude that hedge funds were different from mutual funds (Do, Faff and Wickramanayake, 2005).
The industry of hedge fund in Australia is less developed than US since Australia started its hedge fund in 1990s. By 2003, the managed funds had grown by 20% per year to about two hundred hedge funds (APRA, 2003); it appears that in Australia hedge funds are turning out to be undeniably significant but the research on hedge funds remains scarce. In Australia, the 2001 Corporation Act required every hedge fund be registered under ASIC unless there were 20 investors or less; this gave many managers of hedge fund a free regulatory environment with more freedom to select their strategies (Do et al, 2005).
Generally, hedge funds are an extremely unregulated form of funds which concentrates on “high net worth” persons and the main difference between mutual funds and hedge funds in Australia or US is mainly regulatory environment (Do et al, 2005). Derivatives and short selling are not common in many developing countries because these markets do not have instruments like those found in industrialized nations. Thus, more people are concerned about the value that is added by hedge funds, particularly when compared against conventional mutual funds common in developing economies (Eling and Faust, 2010).
Results
This research study by Eling and Faust (2010) found that the market-related factors are better at clarifying the variations in the developing nations’ returns than those found at developed nations, particular factor models. The model used in the study explained the large percentage of variation in returns from mutual fund compared to hedge funds. The authors also found that hedge funds offer higher returns as well as alphas compared to mutual funds (Eling and Faust, 2010). The researcher’s hypothesis which stated “hedge funds and mutual funds have different abilities in generating returns during bear markets” was analyzed by conducting tests on factor exposure, structural breaks and performance analysis across different economies (Eling and Faust, 2010). The hypothesis was not confirmed as the study found out hedge funds are more exposed to risk and that is why they need to be actively managed unlike mutual funds (Eling and Faust, 2010).
Contributions
The researchers developed a model that can be used by investors in identifying the fund that has a superior performance in which they can invest (Eling and Faust, 2010). Although historical performance does not essentially indicate future earnings, investors greatly rely on historical performance when deciding on the best investment to undertake. The model may be used by reward managers to determine compensation as it can detect if performance of the fund is as a result of passive investment. Finally, the model is suitable in risk management since it enables disclosing of underlying assets that assist in recognizing the extent of fund exposure to risks (Eling and Faust, 2010).
Future research areas
All the same further research need to be carried out on whether the current developing nations’ hedge funds are similar with hedge funds from developed nations since in recent past developing nations’ hedge funds have been active in transferring their allocation of asset based on the style being used. This shift may be due to emergence of new tools like futures and options in developing nations where there is no restriction for hedge funds in utilizing them.
References
APRA. (2003). APRA Report on hedge fund survey. Web.
Bali, T., Brown, S. and Caglayan, M. (2011). Do hedge funds’ exposures to risk factors predict their future returns? Journal of Financial Economics, 101:36- 68.
Do, V., Faff, R. and Wickramanayake, J. (2005). An empirical analysis of hedge fund performance: The case of Australian hedge funds industry. Journal of multinational financial management, 15:377-393.
Eling, M. and Faust, R. (2010). The performance of hedge funds and mutual funds in emerging markets. Journal of Banking & Finance, 34:1993-2009.
Fung, W. and Hsieh, D. (1997). Empirical characteristics of dynamic trading strategies: the case of hedge funds. Review of Financial Studies, 10 (2):275– 302.