Bloomberg News

Hedge Fund Secrets Lie in Short Term Over Luck: Cutting Research

December 20, 2013

The best hedge fund managers tend to find profits in short-term, contrarian bets.

That’s the finding of a study published this year by Russell Jame of the University of Kentucky and set to be presented next month at the American Economic Association’s annual meeting in Philadelphia.

Investigating an industry that has grown to over $2 trillion from $38 billion in 1990, Jame found the top 30 percent of hedge funds outperform rivals by a statistically significant 0.25 percent per month over the subsequent year, indicating their superior performance persists.

Star hedge funds secure profits over short periods, with more than 25 percent of an annual outperformance occurring within a month after a trade. The profits are also often made when managers have bet against the prevailing market view.

The winning funds are net buyers of so-called growth stocks, which are those of companies whose earnings are forecast to grow faster than the market average. They also don’t trade more frequently or more profitably prior to corporate earnings’ announcements, undermining any idea that insider trading explains how they make profits.

Jame’s sample featured 74 hedge fund management companies managing money for 253 different clients from 1999 to 2010.

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Inflation in the wake of past financial crises reflected the aggressive expansion of money supply, which suggests current central bankers will be successful in spurring prices, according to an economic adviser to the Swiss National Bank.

“Excess liquidity has always been followed by persistent increases in inflation,” Samuel Reynard said in a November study for the Washington-based Peterson Institute for International Economics. “Current quantitative easing policies should lead to increasing and persistent inflation over the next years.”

Reynard studied how inflation behaved after crises in Argentina, Japan, the U.S. and Switzerland. He found that while Argentine banks transmitted monetary policy in the early 2000s with an expansion of monetary aggregates, Japanese banks failed to pass on central bank stimulus in the 1990s and money supply fell, resulting in deflation.

“There has never been a situation of excess broad money (created by the banking system) which has not been followed by increasing inflation, and that the increase in inflation occurs after several years lags,” said Reynard.

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The worldwide recession didn’t curtail the trend of workers in developed countries to delay retirement, according to a study for the U.S. Social Security Administration.

The participation rate for 60- to 64-year-old men and women in 20 high-income countries rose 1.5 percentage points per year between 2007 and 2012, Gary Burtless and Barry Bosworth of the Brookings Institution in Washington wrote in the report published this week. That rate had risen by an average 0.4 points a year between 1989 and 2007.

The acceleration was even greater for 65- to 69-year-olds, with the participation rate jumping from 0.1 point to 0.8 point. The rate of increase in the 70- to 74-year-olds age group also rose.

“Longer life spans, improved health at older ages and altered economic incentives for work in old age contributed to the trends,” said Burtless and Bosworth.

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The U.S. energy boom is also a boon for consumers.

The average U.S. household will save between $425 and $725 each year in energy costs due to the slide in natural gas prices since 2005, according to a Dec. 18 report by the Boston Consulting Group.

The savings could potentially reach $1,200 by 2020 -- the equivalent of a boost in average disposable income of 10 percent.

Wholesale natural gas prices have fallen about 50 percent since 2005 amid the development of fracking, which draws on reserves in shale-rock formations.

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The size of a country’s financial market may have determined how much it suffered this year when the Federal Reserve began signaling it would start tapering its monthly asset buying.

A Dec. 12 study by Barry Eichengreen of the University of California, Berkeley, and Poonam Gupta of the World Bank found nations with larger markets experienced “more pressure on the exchange rate, foreign reserves and equity prices” between April and August as Fed Chairman Ben S. Bernanke raised the prospect of curtailing asset-buying.

“We interpret this as investors being able to better rebalance their portfolios when the target country has a relatively large and liquid financial market,” Eichengreen and Gupta said. “This suggests that having a large and liquid market can be a mixed blessing when a country is subject to financial shocks coming from beyond its borders.”

* * *

The more mentions a company gets in the financial press, the greater the trading of its shares.

A study of 1,821 issues of the Financial Times from January 2007 to December 2012 found a strong correlation between reports on the companies comprising the Dow Jones Industrial Average (INDU) and how much they were traded the day of the article.

“A greater number of mentions of a company in the news on a given morning corresponded to a greater volume of trading for that company during the same day, as well as a greater change in price for a company’s stocks,” said co-author Merve Alanyali of the Centre for Complexity at the University of Warwick. The other co-authors were Tobias Preis and Suzy Moat of the Warwick Business School.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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