University of Oulu

The effects of liquidity and share restrictions on hedge fund performance in bull and bear markets

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Author: El-Alawa, Yasmin1
Organizations: 1University of Oulu, Oulu Business School, Department of Finance, Finance
Format: ebook
Version: published version
Access: open
Online Access: PDF Full Text (PDF, 0.6 MB)
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Language: English
Published: Oulu : Y. El-Alawa, 2016
Publish Date: 2016-06-13
Physical Description: 78 p.
Thesis type: Master's thesis
Tutor: Tolonen, Pekka
Reviewer: Perttunen, Jukka
Tolonen, Pekka
Hedge funds are increasingly becoming a popular alternative investment vehicle. They are much more flexible and can freely choose from a pool of investment strategies due to their limited regulations. This gives them the flexibility to exploit opportunities in order to generate high returns at low risk. In order to have access to the freedom and flexibility to engage in different investment strategies, hedge funds often impose share restrictions in the form of lockup, redemption notice period and redemption frequency period to limit the ease with which investors can have access to their investment (limited liquidity). In this study, we evaluate the effects that share restriction could have on the performance of hedge funds in both crisis and non-crisis periods. We find that consistent with previous studies hedge fund performance is positively related with share restrictions. That is, funds that impose stricter share restriction have a better performance in terms of returns and alphas. This is especially seen in the non-crisis period where funds that are more illiquid are able to generate and illiquidity premium for investors to reward them for limiting their investment. However, in the crisis period we find out that this illiquidity premium changes into an illiquidity discount. We also find that funds that impose stricter share restrictions are more volatile and are more likely to take on more risky investment in order reap an illiquidity premium. Our results show a positive correlation between the three share restrictions. Thus, in our study we find that funds that impose one share restriction are more likely to impose the others. Hedge funds with stricter share restriction mostly invest in illiquid assets. We find that the underperformance of illiquid funds during the crisis was majorly driven by styles consisting mostly of illiquid funds such as relative value and event driven styles. We also investigate the performance of funds with an asset-liability mismatch- funds holding a combination of illiquid asset portfolios and weak share restrictions. Our findings suggest that funds that have an asset-liability mismatch perform particularly poorly during the crisis and that there are possibilities to prevent an asset-liability mismatch by ensuring a proper alignment of share restrictions with asset portfolio liquidity. This study contributes to previous academic studies by investigating whether after the crisis period hedge funds yielded comparatively high returns as prior to the crisis period. We compare hedge funds returns from before, during and after the crisis to see if during the period preceding the crisis hedge funds continued reaping high return as they did prior to the crisis. We do this to prevent generalizing the effect of share restrictions on hedge fund performance to all market conditions. The results from our contribution shows that just like most industries the hedge fund industry did not earn as high returns as they did before the crisis (even though they had positive returns). It seems that they were struck severely by the financial crisis and have been unable to pick up quickly to where they were (in terms of returns) prior to the financial crisis
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Copyright information: © Yasmin El-Alawa, 2016. This publication is copyrighted. You may download, display and print it for your own personal use. Commercial use is prohibited.