Hedge funds are likely to become more transparent due to investor demand and regulatory pressures, says a leading expert on the industry.
Dr Olga Kolokolova, Senior Lecturer in Finance at Alliance MBS, has been studying the industry for a decade and has tracked its growing impact on global financial and investment markets.
She says while hedge funds started life as predominantly private boutiques for high net-worth individuals, today’s funds also attract investments from large institutions. She says the $3tn industry has matured rapidly and is now having a significant impact on markets. “At the same time internal pressure from regulated institutional investors is likely to push hedge funds into more transparent and less risky investment strategies.”
Impact
Dr Kolokolova says the industry is also dramatically increasing in size, while at the same time we are witnessing the rise of ‘mega’ hedge funds which dominate the market. “Today a quarter of hedge funds control 90% of all assets in the industry, with the top one per cent of ‘mega’ hedge funds controlling 80% of all assets.”
However despite their size and potential market impact, she says the funds still remain quite secretive. She adds: “Typically to access even basic information about the funds one has had to subscribe to commercial databases, and even then you can only get hold of limited information.
“But this situation is now changing. Hedge funds are becoming more regulated and, in particular, large hedge fund management companies now have to disclose more information to the US Federal Reserve in relation to their positions in US equities. As such, I think we will see the funds start to become more transparent from both regulatory and investor pressure. Part of the reason is also that private investors themselves are now more heavily regulated so hedge funds have had to follow suit.”
Research
Given this growth, the hedge fund industry has become an area of increasing research with the number of academic papers accelerating year on year.
Last year Dr Kolokolova also organised an Alliance-funded conference in Manchester on the role of hedge funds and other collective investment funds which was attended by leading global experts.
She herself has just published a paper with Professor Ser-Huang Poon from Alliance MBS and Dr Ming-Tsung Lin from De Montfort University on the impact of hedge fund trading on the bond markets, which has appeared in The Journal of Banking & Finance. The paper concludes that flow-induced hedge fund trading has a profound impact on corporate bond yields, especially during times of low market liquidity.
Another paper on managerial risk taking, co-authored with Dr Achim Mattes from Credit Suisse, is due to appear in The Financial Review later this year. The paper shows that due to the interplay of explicit and implicit managerial incentives, the actual risk-taking in hedge funds is very complex and non-linear with respect to past fund performance, and also exhibits a strong seasonal pattern.
M&A
In another paper Dr Kolokolova has worked with Alliance MBS colleague Dr Ning Gao and Dr Mattes on analysing the impact of hedge funds on M&A transactions. This research shows that the short-term nature of hedge funds, which hold target firms, and their desire for liquidity leads to a higher proportion of cash payment in M&A transactions, which may be sub-optimal from the point of view of long-term investors.
She adds that there is plenty more research to now pursue. “A lot has been already done to enhance our understanding of the hedge fund industry, its impact on investors and the markets. But we are far from the end. The industry develops and changes continuously. Every day brings new challenges and new questions to answer.”
Papers
Too big to ignore? Hedge fund flows and bond yields
A time to scatter stones, and a time to gather them: the annual cycle in hedge fund risk taking