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Do Hedge Funds Profit From Mutual-Fund Distress?

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Author Info
Joseph Chen
Samuel Hanson
Harrison Hong
Jeremy C. Stein

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Abstract

This paper explores the question of whether hedge funds engage in front-running strategies that exploit the predictable trades of others. One potential opportunity for front-running arises when distressed mutual funds -- those suffering large outflows of assets under management -- are forced to sell stocks they own. We document two pieces of evidence that are consistent with hedge funds taking advantage of this opportunity. First, in the time series, the average returns of long/short equity hedge funds are significantly higher in those months when a larger fraction of the mutual-fund sector is in distress. Second, at the individual stock level, short interest rises in advance of sales by distressed mutual funds.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13786.

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Date of creation: Feb 2008
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Handle: RePEc:nbr:nberwo:13786

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G20 - Financial Economics - - Financial Institutions and Services - - - General
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
H0 - Public Economics - - General

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  1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2005. "Predatory Trading," Journal of Finance, American Finance Association, vol. 60(4), pages 1825-1863, 08. [Downloadable!] (restricted)
    Other versions:
  2. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March. [Downloadable!] (restricted)
  3. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February. [Downloadable!] (restricted)
  4. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(2), pages 275-302.
  5. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June. [Downloadable!] (restricted)
    Other versions:
  6. Mark Mitchell, 2001. "Characteristics of Risk and Return in Risk Arbitrage," Journal of Finance, American Finance Association, vol. 56(6), pages 2135-2175, December. [Downloadable!] (restricted)
  7. Getmansky, Mila & Lo, Andrew W. & Makarov, Igor, 2004. "An econometric model of serial correlation and illiquidity in hedge fund returns," Journal of Financial Economics, Elsevier, vol. 74(3), pages 529-609, December. [Downloadable!] (restricted)
    Other versions:
  8. An Yan, 2006. "Value of Conglomerates and Capital Market Conditions," Financial Management, Financial Management Association, vol. 35(4), Winter.
  9. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February. [Downloadable!] (restricted)
  10. Fang Cai, 2003. "Was there front running during the LTCM crisis," International Finance Discussion Papers 758, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 14(2), pages 313-41.
  12. Andrea Frazzini & Owen A. Lamont, 2005. "Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns," NBER Working Papers 11526, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. D'Avolio, Gene, 2002. "The market for borrowing stock," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 271-306. [Downloadable!] (restricted)
  14. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(1), pages 63-98. [Downloadable!] (restricted)
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