Three Novel Factors Affecting Hedge Fund Returns_CDMC (May 2016)

THREE NOVEL FACTORS
AFFECTING HEDGE FUND
RETURNS
China Derivatives Market Conference (CDMC)
May 20, 2016 – Suzhou, China
L. Mick Swartz (PhD, CAIA)
University of Southern California
Marshall School of Business
* Special thanks to my research assistant, Farrokh Emami Langroodi

Presentation Outline
 Conceptual Introduction to Three New Ratios
 Drawdown and Run-up Variables Graphical Illustration
 L-Ratio as a Liquidity Factor
 R-Ratio as a Momentum Factor
 D-Ratio as an Average Downside Risk Factor
 Fung & Hsieh Seven-Factor Model
 Data Collection, Model Estimation & Diagnostics

Presentation Outline – continue
 Empirical Results
 Global Macro Strategies
 Emerging Market Strategies
 Asia Regional Strategies
 Equity Hedge Strategies
 Relative Value Strategies
 Event Driven Strategies
 Europe Regional Strategies
 Final Remarks

Conceptual Introduction to Three New Ratios
 The three new ratios are generated with hedge fund strategy’s monthly
excess return in the numerator, as is the case for traditional asset
allocation ratios such as Sharpe ratio.
 The denominator of these ratios includes risk factors that are considered
to be more relevant and vital for hedge fund industry, such as
Drawdown, Run-up, and their corresponding magnitude, duration, and
velocity, as opposed to Std. Dev., Beta etc.
1) L-Ratio is used as a Liquidity factor, i.e. how long (no. of months) it
takes the return of hedge fund to recover from it’s highest fall as the risk
factor
2) R-Ratio is used as a Momentum factor, i.e. how fast the hedge fund
return rises from it’s last drop as the risk factor
3) D-Ratio is used as an Average Drawdown% (Downside Risk) factor, i.e.
the average drawdown% per month as the risk factor

Drawdown & Run-up Variables Graphical Illustration

L-Ratio as a Liquidity Factor
 L-Ratio as a Liquidity Factor
𝐿 − 𝑅𝑎𝑡𝑖𝑜 =
𝐻𝑒𝑑𝑔𝑒 𝐹𝑢𝑛𝑑 𝑒𝑥𝑐𝑒𝑠𝑠 𝑟𝑒𝑡𝑢𝑟𝑛
𝐿𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦 𝑅𝑖𝑠𝑘 𝐹𝑎𝑐𝑡𝑜𝑟
=
𝐻𝑒𝑑𝑔𝑒 𝐹𝑢𝑛𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 − 3 𝑀𝑜𝑛𝑡ℎ 𝐿𝐼𝐵𝑂𝑅 𝑟𝑎𝑡𝑒
𝑀𝑎𝑥. 𝐷𝑟𝑎𝑤𝑑𝑜𝑤𝑛′ 𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛

R-Ratio as a Momentum Factor
 R-Ratio as a Momentum Factor
𝑅 − 𝑅𝑎𝑡𝑖𝑜 =
𝑀𝑜𝑚𝑒𝑛𝑡𝑢𝑚 𝑅𝑖𝑠𝑘 𝐹𝑎𝑐𝑡𝑜𝑟
=
|𝑀𝑎𝑥. 𝑅𝑢𝑛𝑢𝑝′ 𝑠 𝑉𝑒𝑙𝑜𝑐𝑖𝑡𝑦|

D-Ratio as an Average Downside Risk Factor
 D-Ratio as an Average Downside Risk Factor
𝐷 − 𝑅𝑎𝑡𝑖𝑜 =
𝐷𝑜𝑤𝑛𝑠𝑖𝑑𝑒 𝑅𝑖𝑠𝑘 𝐹𝑎𝑐𝑡𝑜𝑟
=
|𝑀𝑎𝑥. 𝐷𝑟𝑎𝑤𝑑𝑜𝑤𝑛 % 𝑀𝑎𝑥. 𝐷𝑟𝑎𝑤𝑑𝑜𝑤𝑛′ 𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛|

Fung & Hsieh Seven-Factor Model
 Fung & Hsieh 7-Factor Model Variables*:
1) S&P500: Standard & Poor's 500 stock return.
2) SML: Russell 2000 Small Cap return  Russell 1000 Large Cap return
3) T10Y: Month end-to-month end change in the Federal Reserve’s 10 year constant maturity yield.
4) Credit Spread: month end-to-month end change in the difference between Moody’s Baa yield and the
Federal Reserve’s 10 year constant maturity yield.
5) Bd. Opt: return of a portfolio of lookback straddles on bond futures.
6) FX Opt: return of a portfolio of lookback straddles on currency futures.
7) Com. Opt: return of a portfolio of lookback straddles on commodity futures.
Note: if 5,6 or 7 are significant, then GARCH should be implemented.
* Fung, W., Hsieh, D., 2004. Hedge fund benchmarks: a risk-based approach. Financial Analyst Journal
60(5), 65–80.

Data Collection, Model Estimation & Diagnostics
 Data Collection and Variable Construction
• Monthly return of 55 HFRX hedge fund strategies collected from “HFR Inc.”
• Monthly total return of S&P500 index, CRB index, MSCI World index, Russell
2000 index and Russell 1000 growth and value indices (for SML and HML),
and other countries’ market indices, are collected from “Global Financial Data”.
• 3-month and 12-month LIBOR rates, U.S. 10-year T-Bond and 3-month T-Bill,
and Moody’s Baa Corp. Bond yield for Credit Spread, are collected from
“Federal Reserve Bank of St. Louis”.
• Statistical variables such as Std. Dev., Skew, excess Kurtosis, Sharpe Ratio,
Sortino Ratio, Max. Drawdown percentage, Duration, and Velocity; Max. Run-
up percentage, Duration, and Velocity, and new ratios are calculated and used
as independent variables.

 Model Estimation and Diagnostics
 Hedge fund return models are estimated by Ordinary Least Square (OLS)
technique or one of the ARCH family techniques if needed.
 To generate robust models, each model is tested and corrected for:
• Stationarity (Augmented Dickey-Fuller Unit Root test, corrected by first differencing),
• Serial-Correlation (Durbin-Watson test, corrected by first order autoregression term),
• Multi-Collinearity (Variance Inflation Factor test < 10, corrected by elimination),
• Conditional Heteroskedasticity (tested and corrected by ARCH, GARCH, or EGARCH
modeling).
• Heteroskedasticity (White test, corrected by Newey–West HAC estimation).
 The Akaike information criterion (AIC) and Schwarz information criterion (SIC)
are used for the best model selection, with the SIC favored, as an indicator of the
parsimony model, if there is a disagreement among these indicators.

Global Macro
Strategies
Empirical Results

Macro/CTA
Dependent Variable: Macro/CTA return
Sample Period: January 1998 – December 2014
FH 7-Factor Model CAPM Model Fama-French Model
Variable Coefficient Variable Coefficient Variable Coefficient
Intercept 0.003 Intercept −0.002
S&P500 0.01 L-Ratio −0.80*
SML 0.10** S1 0.02*
T10Y −0.53
Credit Spread 0.33
Bd. Opt 2.10
FX Opt −0.03
Com. Opt 0.11*
Adj. R-squared 8.15% 24.25%
Akaike info criterion (AIC) −4.68 −5.17
Schwarz info criterion (SIC) −4.55 −5.06
Estimation Technique OLS EGARCH
Significance Levels: *** 10% and ** 5% and * 1%

Macro: Active Trading
Dependent Variable: Macro: Active Trading return
Intercept 0.005** Intercept −0.008*
S&P500 −0.002 D-Ratio 0.001*
SML −0.10***
T10Y 9.82
Credit Spread 0.08
Bd. Opt 0.01
FX Opt −0.03
Com. Opt 0.06***
Estimation Technique OLS GARCH

Macro: Commodity
Dependent Variable: Macro: Commodity return
Intercept 0.003 Intercept −0.084*
S&P500 −0.09 R-Ratio 6.98*
SML 0.09 CRB 0.12**
T10Y 12.90 Max Drawdown% −0.33*
Credit Spread 0.60 S5 0.76*
Bd. Opt 0.03 D-Ratio 0.002*
FX Opt −0.03
Com. Opt 0.17*
Adj. R-squared 20.87% 40.28%
Estimation Technique OLS OLS

Macro: Commodity–Agriculture
Dependent Variable: Macro: Commodity–Agriculture return
S&P500 −0.02 R-Ratio 2.81*
SML −0.01 CRB 0.12*
T10Y −3.33 Kurtosis 0.006*
Credit Spread −0.14
Bd. Opt 0.10
FX Opt −0.02
Com. Opt 0.15*
Estimation Technique OLS ARCH

Macro: Commodity–Energy
Dependent Variable: Macro: Commodity–Energy return
Intercept 0.002 Intercept 0.002
S&P500 −0.04 CRB 0.24*
SML −0.14 D-Ratio 0.003*
T10Y 23.80 L-Ratio −1.23*
Credit Spread 0.41
Bd. Opt 2.49
FX Opt 0.17
Com. Opt 0.40*
Adj. R-squared 27.68% 47.08%

Macro: Commodity–Metals
Dependent Variable: Macro: Commodity–Metals return
Intercept −0.005 Intercept −0.003
S&P500 −0.23 CRB 0.63*
SML 0.48** R-Ratio 7.97*
T10Y −15.30 Run-up Duration −0.001*
Credit Spread 7.26 Drawdown Duration 0.002*
Bd. Opt 6.72
FX Opt −0.16
Com. Opt 0.78*
Adj. R-squared 34.12% 37.17%

Macro: Currency
Dependent Variable: Macro: Currency return
Intercept 0.001 Intercept 0.04*
S&P500 0.04 Sortino Ratio 0.08*
SML 0.02 D-Ratio 0.001*
T10Y 15.53 S4 −0.05*
Bd. Opt 0.28
FX Opt −0.04
Com. Opt −0.02

Macro: Discretionary Thematic
Dependent Variable: Macro: Discretionary Thematic return
S&P500 0.03 CRB 0.22*
SML 0.02 Max Drawdown% −0.15*
T10Y −26.71** R-Ratio 8.17*
Credit Spread 0.89 L-Ratio −0.47*
Bd. Opt −1.11 S5 0.84*
FX Opt 0.07
Com. Opt 0.30*
Adj. R-squared 36.88% 51.47%

Macro: Multi-Strategy
Dependent Variable: Macro: Multi-Strategy return
Intercept −0.0002 Intercept −0.01***
S&P500 0.11* S&P500 0.16*
SML −0.01 Run-up Velocity 0.001*
T10Y 1.03
Credit Spread 3.15**
Bd. Opt −0.68
FX Opt 0.01
Com. Opt 0.08**
Adj. R-squared 19.46% 17.94%

Macro: Systematic Diversified
Dependent Variable: Macro: Systematic Diversified return
Intercept 0.005 Intercept 0.03**
S&P500 −0.20** Sortino Ratio 0.05*
SML 0.02 Run-up Velocity −0.003*
T10Y 18.15 L-Ratio −0.98*
Credit Spread 0.02 S&P500 −0.14**
Bd. Opt 3.94**
FX Opt 0.04
Com. Opt 0.12***

Emerging Market
Strategies
Empirical Results

Emerging Markets Composite Index
Dependent Variable: Emerging Markets Composite Index return
Intercept −0.003 Intercept −0.04* Intercept −0.05*
MSCI 0.33* MSCI 0.23* MSCI 0.33*
SML −0.13 R-Ratio 6.06* HML (Value Prem.) −0.35*
T10Y −0.88 Max Drawdown% −0.10* R-Ratio 6.02*
Credit Spread 3.60** Max Drawdown% −0.11*
Bd. Opt 0.58
FX Opt 0.18
Com. Opt 0.18*
Adj. R-squared 52.61% 49.46% 58.76%
Akaike info criterion (AIC) −5.11 −5.31 −5.28
Schwarz info criterion (SIC) −4.91 −5.13 −5.15
Estimation Technique OLS GARCH OLS

Total Emerging Market Index
Dependent Variable: Total Emerging Market Index return
Intercept 0.002 Intercept −0.02* Intercept −0.03*
MSCI 0.36* MSCI 0.45* MSCI 0.44*
SML −0.09 Sharpe Ratio 0.01* HML (Value Prem.) −0.25*
T10Y 6.45 Kurtosis 0.004* Sharpe Ratio 0.02*
Credit Spread 0.88 Kurtosis 0.006*
Bd. Opt −0.98
FX Opt −0.03
Com. Opt 0.13*
Adj. R-squared 75.83% 75.19% 78.29%
Estimation Technique OLS ARCH OLS

Multi-Emerging Markets Index
Dependent Variable: Multi-Emerging Markets Index return
Intercept 0.002 Intercept −0.001 Intercept −0.02*
MSCI 0.51* MSCI 0.43* MSCI 0.51*
SML −0.19 D-Ratio 0.001** HML (Value Prem.) −0.39*
T10Y −19.60 Sortino Ratio 0.02*
Credit Spread 1.00 Max Drawdown% −0.09*
Bd. Opt −1.20 Max Run-up% −0.03*
FX Opt 0.20
Com. Opt 0.18*
Adj. R-squared 71.89% 66.67% 75.99%
Estimation Technique OLS GARCH OLS

Asia ex-Japan Index
Dependent Variable: Asia ex-Japan Index return
Intercept 0.001 Intercept −0.001 Intercept −0.005
MSCI 0.32* MSCI 0.46* MSCI 0.46*
SML 0.04 S3 3.26* S3 4.18*
T10Y −2.90 AR(1) 0.30* HML (Value Prem.) −0.26*
Credit Spread 2.85 AR(1) 0.29*
Bd. Opt −1.24
FX Opt −0.03
Com. Opt 0.19*
Adj. R-squared 42.69% 55.16% 56.19%
Estimation Technique OLS EGARCH GARCH

Brazil Index
Dependent Variable: Brazil Index return
Intercept 0.004 Intercept 0.0004
BOVESPA 0.40* BOVESPA 0.48*
SML 0.07
T10Y 15.25
Bd. Opt 0.46
FX Opt −0.11
Com. Opt 0.11***
Adj. R-squared 63.60% 61.51%

BRIC Index
Dependent Variable: BRIC Index return
Intercept −0.001 Intercept −0.15* Intercept −0.15*
MSCI 0.71* MSCI 0.68* MSCI 0.69*
SML −0.11 S1 0.02* S1 0.02*
T10Y 0.82 Std. Dev. 3.04* HML (Value Prem.) −0.33*
Credit Spread 3.20 L-Ratio −0.45* Std. Dev. 2.96*
Bd. Opt −0.57 S4 0.03* L-Ratio −0.49*
FX Opt 0.22 S4 0.03*
Com. Opt 0.17*
Adj. R-squared 68.82% 79.58% 81.53%
Estimation Technique OLS EGARCH OLS

China Index
Dependent Variable: China Index return
Intercept 0.002 Intercept 0.002 Intercept 0.001
Shanghai Comp 0.18* Shanghai Comp 0.14* Shanghai Comp 0.13*
SML 0.17 D-Ratio 0.01* D-Ratio 0.01*
T10Y 1.98 Sharpe Ratio 0.04* R-Ratio 8.19*
Credit Spread 4.97** R-Ratio 8.93* Sharpe Ratio 0.03*
Bd. Opt −1.83 HML (Value Prem.) −0.29*
FX Opt −0.15 SML (Size Prem.) 0.19**
Com. Opt 0.16**
Adj. R-squared 44.71% 57.62% 60.36%
Estimation Technique OLS OLS OLS

India Index
Dependent Variable: India Index return
Nifty 0.79* Nifty 0.80*
SML −0.27** D-Ratio 0.009*
T10Y 37.97
Bd. Opt −1.03
FX Opt −0.56*
Com. Opt −0.12
Adj. R-squared 78.41% 77.16%

Korea Index
Dependent Variable: Korea Index return
KOSPI 0.54* KOSPI 0.67*
SML 0.20
T10Y 22.20
Bd. Opt 5.63*
FX Opt −0.58*
Com. Opt 0.002
Adj. R-squared 73.75% 62.47%

Latin America Index
Dependent Variable: Latin America Index return
MSCI 0.40* MSCI 0.47*
SML −0.08 D-Ratio 0.002*
T10Y −0.31 AR(1) 0.26*
Credit Spread 2.38
Bd. Opt −1.44
FX Opt 0.05
Com. Opt 0.16*
Adj. R-squared 63.46% 61.67%

MENA (Middle East/North Africa) Index
Dependent Variable: MENA Index return
MSCI 0.50* MSCI 0.55*
SML 0.03 D-Ratio 0.001*
T10Y 28.02**
Credit Spread 1.79
Bd. Opt −1.21
FX Opt 0.13
Com. Opt 0.11*
Adj. R-squared 76.04% 71.35%

Russia Index
Dependent Variable: Russia Index return
Intercept 0.005 Intercept −0.007*** Intercept 0.002
MICEX 0.51* MICEX 0.57* MICEX 0.57*
SML −0.02 Sharpe Ratio 0.03* HML (Value Prem.) 0.29**
T10Y 23.35 R-Ratio 4.56* D-Ratio 0.01*
Credit Spread −1.96 AR(1) 0.38*
Bd. Opt −0.05
FX Opt −0.30*
Com. Opt 0.09
Adj. R-squared 79.88% 78.91% 79.10%
Estimation Technique OLS GARCH GARCH

Russia/Eastern Europe Index
Dependent Variable: Russia/Eastern Europe Index return
MSCI 0.52* MSCI 0.61*
SML −0.08 R-Ratio 9.69*
T10Y 20.08 L-Ratio −0.58*
Bd. Opt −1.09
FX Opt −0.01
Com. Opt 0.14***
Adj. R-squared 58.37% 67.10%

Asia Regional
Strategies
Empirical Results

Asia Composite Hedge Fund Index
Dependent Variable: Asia Composite Hedge Fund Index return
Intercept 0.0003 Intercept −0.003 Intercept −0.005**
MSCI 0.37* MSCI 0.36* MSCI 0.34*
SML −0.03 R-Ratio 1.44** R-Ratio 1.91*
T10Y 14.04 HML (Value Prem.) −0.15**
Credit Spread 2.06
Bd. Opt 0.12
FX Opt 0.16**
Com. Opt 0.06
Adj. R-squared 52.57% 52.05% 54.50%
Estimation Technique OLS EGARCH GARCH

Asia Equally Weighted Index
Dependent Variable: Asia Equally Weighted Index return
Intercept 0.001 Intercept −0.005***
MSCI 0.37* MSCI 0.35*
SML −0.03 D-Ratio 0.001*
T10Y 14.90
Credit Spread 1.63
Bd. Opt 0.07
FX Opt 0.16***
Com. Opt 0.05
Adj. R-squared 50.74% 50.93%

Asia with Japan Index
Dependent Variable: Asia with Japan Index return
Intercept 0.002 Intercept −0.007**
MSCI 0.26* MSCI 0.30*
SML −0.04 R-Ratio 2.81*
T10Y 8.28 Kurtosis 0.006*
Credit Spread 2.13
Bd. Opt −0.05
FX Opt 0.11
Com. Opt 0.08**
Adj. R-squared 34.64% 36.41%

Japan Index
Dependent Variable: Japan Index return
TOPIX 0.37* TOPIX 0.36*
SML −0.02
T10Y 26.87*
Credit Spread 0.40
Bd. Opt 1.44
FX Opt 0.04
Com. Opt −0.03
Adj. R-squared 64.12% 62.73%

Equity Hedge
Strategies
Empirical Results

Equity Hedge
Dependent Variable: Equity Hedge return
S&P500 0.30* S&P500 0.35* S&P500 0.32*
SML 0.16* R-Ratio 3.71* R-Ratio 2.61*
T10Y 15.48** Skew −0.006* SML (Size Prem.) 0.16*
Credit Spread −0.16 L-Ratio −0.28* Skew −0.007*
Bd. Opt 1.68**
FX Opt 0.04
Com. Opt 0.10*
Adj. R-squared 57.34% 55.24% 59.63%

EH: Energy/Basic Materials
Dependent Variable: EH: Energy/Basic Materials return
Intercept −0.001 Intercept 0.12*
S&P500 0.21* S&P500 0.39*
SML 0.09 Drawdown Velocity 0.001*
T10Y 26.34 Run-up Velocity −0.002*
Credit Spread 2.98
Bd. Opt −1.43
FX Opt −0.03
Com. Opt 0.35*
Adj. R-squared 60.38% 50.43%
Estimation Technique OLS ARCH

EH: Equity Market Neutral
Dependent Variable: EH: Equity Market Neutral return
Intercept 0.003 Intercept 0.02* Intercept 0.0008
S&P500 −0.02 Max Run-up% −0.05* SML (Size Prem.) 0.06**
SML 0.05** S1 −0.003* AR(1) 0.21*
T10Y 1.96 L-Ratio 2.13*
Bd. Opt −0.13
FX Opt −0.03
Com. Opt 0.01
Adj. R-squared 5.10% 7.27% 6.20%
Estimation Technique OLS EGARCH OLS

EH: Fundamental Growth
Dependent Variable: EH: Fundamental Growth return
S&P500 0.26* S&P500 0.39* S&P500 0.40*
SML −0.01 D-Ratio 0.002* D-Ratio 0.001*
T10Y 5.57 HML (Value Prem.) −0.39*
Credit Spread −1.0 S4 0.02*
Bd. Opt −1.21
FX Opt −0.04
Com. Opt 0.16*
Adj. R-squared 38.14% 43.53% 50.29%

EH: Fundamental Value
Dependent Variable: EH: Fundamental Value return
Intercept −0.0001 Intercept -0.004*** Intercept −0.004**
S&P500 0.32* S&P500 0.38* S&P500 0.39*
SML −0.02 S1 0.006* S1 0.006*
T10Y 27.44* AR(1) 0.23** HML (Value Prem.) −0.17**
Credit Spread −0.04 AR(1) 0.23**
Bd. Opt 0.22
FX Opt 0.07
Com. Opt 0.12*
Adj. R-squared 62.95% 59.33% 60.62%

EH: Multi-Strategy
Dependent Variable: EH: Multi-Strategy return
Intercept 0.004 Intercept −0.002 Intercept −0.001
S&P500 0.40* S&P500 0.55* S&P500 0.53
SML 0.23* S1 0.005* S1 0.005
T10Y 7.28 SML (Size Prem.) 0.24
Credit Spread 0.50
Bd. Opt −3.39**
FX Opt −0.13
Com. Opt 0.12**
Adj. R-squared 69.04% 61.77% 64.20%

EH: Quantitative Directional
Dependent Variable: EH: Quantitative Directional return
Intercept 0.008** Intercept 0.09*
S&P500 0.14* S&P500 0.20*
SML 0.15** Max Run-up% −0.09*
T10Y 6.53 Drawdown Velocity −0.001*
Credit Spread −2.65*** S3 5.66*
Bd. Opt 0.91 Std. Dev. −2.98*
FX Opt 0.07
Com. Opt 0.07
Adj. R-squared 24.23% 39.00%

EH: Short Bias
Dependent Variable: EH: Short Bias return
Intercept 0.002 Intercept 0.02* Intercept 0.005**
S&P500 −0.56* S&P500 −0.62* S&P500 −0.51*
SML −0.46* Run-up Duration −0.002* SML −0.48*
T10Y −4.51 Max Drawdown% −0.08* Drawdown Velocity 0.0003*
Credit Spread −2.12 Sharpe Ratio 0.02*
Bd. Opt 0.16
FX Opt −0.06
Com. Opt 0.01
Adj. R-squared 77.06% 69.41% 78.83%

EH: Technology/Healthcare
Dependent Variable: EH: Technology/Healthcare return
Intercept 0.007** Intercept −0.07* Intercept 0.02***
S&P500 0.26* S&P500 0.33* S&P500 0.29*
SML 0.11 Sortino Ratio 0.03* HML (Value Prem.) −0.29*
T10Y 15.18 S4 −0.03* Sortino Ratio 0.01*
Credit Spread −0.66 Kurtosis −0.008* Run-up Velocity −0.001**
Bd. Opt 0.03 Std. Dev. 3.23* SML (Size Prem.) 0.20*
FX Opt 0.05
Com. Opt 0.02
Adj. R-squared 39.26% 45.46% 52.39%

Relative Value
Strategies
Empirical Results

Relative Value Arbitrage
Dependent Variable: Relative Value Arbitrage return
S&P500 0.09* S&P500 0.10*
SML 0.02 R-Ratio 1.79*
T10Y 11.45*** AR(1) 0.46*
Bd. Opt −0.48
FX Opt 0.03
Com. Opt 0.08*
Adj. R-squared 47.55% 42.86%

RV: Energy Infrastructure
Dependent Variable: RV: Energy Infrastructure return
Intercept 0.009** Intercept −0.10* Intercept −0.01
S&P500 0.30* S&P500 0.38* S&P500 0.39*
SML −0.12 R-Ratio 6.73* HML (Value Prem.) −0.47*
T10Y 7.66 Std. Dev. 2.56* R-Ratio 5.14*
Credit Spread 0.03 Drawdown Velocity 0.001*
Bd. Opt −2.54 Max Drawdown% −0.10*
FX Opt 0.16
Com. Opt 0.24*
Adj. R-squared 49.15% 41.90% 48.45%

RV: Fixed Income–Asset Backed
Dependent Variable: RV: Fixed Income–Asset Backed return
Intercept 0.009* Intercept −0.02*
S&P500 0.08* Drawdown Duration 0.004*
SML −0.03 S&P500 0.05*
T10Y 0.21 S4 0.15*
Credit Spread 0.97 AR(1) 0.37*
Bd. Opt 0.13
FX Opt 0.11**
Com. Opt 0.06**
Adj. R-squared 30.48% 41.46%

RV: Fixed Income–Convertible Arbitrage
Dependent Variable: RV: Fixed Income–Convertible Arbitrage return
S&P500 0.12* S&P500 0.06*
SML 0.01 R-Ratio 3.93*
T10Y −13.58*** AR(1) 0.77*
Bd. Opt −0.50
FX Opt 0.09
Com. Opt 0.14*
Adj. R-squared 43.37% 37.50%

RV: Fixed Income–Corporate
Dependent Variable: RV: Fixed Income–Corporate return
Intercept 0.008** Intercept 0.004*
S&P500 0.17* S&P500 0.19*
SML −0.002
T10Y 9.25
Credit Spread −3.11***
Bd. Opt 0.42
FX Opt 0.11***
Com. Opt 0.12*
Adj. R-squared 54.45% 45.25%

RV: Fixed Income–Sovereign
Dependent Variable: RV: Fixed Income–Sovereign return
S&P500 0.22* S&P500 0.23*
SML −0.04 R-Ratio 0.91**
T10Y −1.73
Credit Spread 1.87
Bd. Opt 1.93
FX Opt 0.19***
Com. Opt 0.22*
Adj. R-squared 38.07% 27.32%

RV: Multi-Strategy
Dependent Variable: RV: Multi-Strategy return
S&P500 0.13* S&P500 0.18*
SML 0.001 Max Run-up% −0.06*
T10Y 4.62 Drawdown Duration 0.001*
Credit Spread 1.50
Bd. Opt −0.80
FX Opt −0.004
Com. Opt 0.10*
Adj. R-squared 48.15% 46.39%

RV: Real Estate
Dependent Variable: RV: Real Estate return
Intercept −0.004 Intercept 0.02** Intercept 0.002
S&P500 0.29* S&P500 0.31* S&P500 0.30*
SML 0.18* Max Run-up% −0.11* SML (Size Prem.) 0.12**
T10Y 7.90 L-Ratio 0.97**
Credit Spread 3.07 Max Drawdown% −0.07*
Bd. Opt 0.36
FX Opt 0.09
Com. Opt 0.09*
Adj. R-squared 56.83% 54.98% 54.00%

RV: Volatility
Dependent Variable: RV: Volatility return
S&P500 0.07 D-Ratio 0.001*
SML 0.01 L-Ratio −0.28**
T10Y 24.73*
Bd. Opt 0.72
FX Opt 0.07
Com. Opt −0.04

RV: Yield Alternative
Dependent Variable: RV: Yield Alternative return
S&P500 0.25* S&P500 0.34*
SML −0.006 S1 0.01*
T10Y 2.40 L-Ratio −0.60*
Credit Spread 1.07
Bd. Opt −2.85**
FX Opt 0.21***
Com. Opt 0.21*
Adj. R-squared 44.62% 42.14%

Event Driven
Strategies
Empirical Results

Event Driven
Dependent Variable: Event Driven return
Intercept 0.003 Intercept 0.003** Intercept −0.02
S&P500 0.22* S&P500 0.25* S&P500 0.24
SML 0.14* S5 0.61* SML (Size Prem.) 0.17
T10Y 18.56* AR(1) 0.33* Max Run-up% −0.01
Credit Spread 0.14 S5 0.71
Bd. Opt 0.43 Drawdown Velocity −0.001
FX Opt 0.06
Com. Opt 0.05**
Adj. R-squared 55.92% 49.52% 53.84%
Estimation Technique OLS GARCH ARCH

ED: Activist
Dependent Variable: ED: Activist return
S&P500 0.60* S&P500 0.74*
SML 0.22** S4 0.02*
T10Y 19.95
Credit Spread 5.96*
Bd. Opt 0.84
FX Opt −0.05
Com. Opt 0.18*
Adj. R-squared 71.50% 66.37%

ED: Credit Arbitrage
Dependent Variable: ED: Credit Arbitrage return
Intercept 0.004* Intercept 0.006*
S&P500 0.10* S&P500 0.11*
SML 0.01 Skew 0.01*
T10Y 24.10* S5 0.45**
Credit Spread 1.27*** AR(1) 0.31*
Bd. Opt −0.16
FX Opt −0.07
Com. Opt 0.03
Adj. R-squared 55.41% 47.10%

ED: Distressed/Restructuring
Dependent Variable: ED: Distressed/Restructuring return
Intercept 0.02* Intercept −0.003 Intercept −0.005***
S&P500 0.14* S&P500 0.16* S&P500 0.17*
SML 0.10* R-Ratio 2.06* R-Ratio 1.95*
T10Y 8.04 AR(1) 0.34* SML (Size Prem.) 0.09*
Credit Spread −8.70* AR(1) 0.39*
Bd. Opt −0.57
FX Opt 0.04
Com. Opt 0.06**
Adj. R-squared 44.77% 36.69% 38.75%
Estimation Technique OLS GARCH EGARCH

ED: Merger Arbitrage
Dependent Variable: ED: Merger Arbitrage return
Intercept 0.001 Intercept 0.006* Intercept 0.006*
S&P500 0.09* S&P500 0.09* S&P500 0.09*
SML 0.05* S5 4.93* S5 4.85*
T10Y 7.37 S3 −5.91** S3 −6.23*
Credit Spread 1.88** SML (Size Prem.) 0.04**
Bd. Opt 0.85***
FX Opt 0.008
Com. Opt 0.03**
Adj. R-squared 23.27% 30.65% 31.98%

ED: Multi-Strategy
Dependent Variable: ED: Multi-Strategy return
Intercept 0.002 Intercept −0.004 Intercept −0.005**
S&P500 0.33* S&P500 0.37* S&P500 0.39*
SML −0.14 S5 2.01* S5 2.18*
T10Y 30.70** HML (Value Prem.) −0.26**
Credit Spread 0.80
Bd. Opt 1.59
FX Opt 0.14
Com. Opt 0.18*
Adj. R-squared 46.48% 43.48% 45.92%

ED: Special Situations
Dependent Variable: ED: Special Situations return
Intercept −0.0004 Intercept −0.002 Intercept −0.001
S&P500 0.29* S&P500 0.32* S&P500 0.32*
SML 0.02 S1 0.007* HML (Value Prem.) −0.31*
T10Y 21.85** AR(1) 0.32* S1 0.007*
Credit Spread 0.58 AR(1) 0.27**
Bd. Opt 1.06
FX Opt 0.15**
Com. Opt 0.12*
Adj. R-squared 57.64% 53.53% 59.09%
Estimation Technique OLS OLS ARCH

Europe Regional
Strategies
Empirical Results

Western/Pan Europe Index
Dependent Variable: Western/Pan Europe Index return
MSCI 0.32* MSCI 0.20*
SML −0.13*** R-Ratio 8.73*
T10Y 8.85 Max Drawdown% −0.26*
Credit Spread −1.21 L-Ratio −0.42*
Bd. Opt −0.27 Max Run-up% −0.06*
FX Opt 0.31*
Com. Opt 0.06
Adj. R-squared 39.66% 57.24%

Northern Europe Index
Dependent Variable: Northern Europe Index return
MSCI 0.18* MSCI 0.12*
SML 0.003
T10Y 7.68
Credit Spread 1.62
Bd. Opt 0.79
FX Opt 0.30*
Com. Opt 0.06***
Adj. R-squared 28.46% 17.73%

Final Remarks
 55 HFRX categories of hedge fund returns are analyzed. Three new factors (D-
Ratio, L-Ratio, and R-Ratio) are introduced as better risk measures for hedge
fund categories than traditional factors.
 The three new factors are dominant in the Macro category, the Relative Value
category, the Emerging Market category, and the Asia regional categories (at
least one of these variables is significant in 74% of these models). These three
variables are not as dominant in the Equity Hedge category (33%) or the Event
Driven category (14%).
 L-Ratio is significant in 12 of 55 categories (21.8%).
 R-Ratio is significant in 17 of 55 categories (30.9%).
 D-Ratio is significant in 13 of 55 categories (23.6%).
 The Sharpe and Sortino ratios are only significant in 4-7 categories of the 55
hedge fund groups.

Three Novel Factors Affecting Hedge Fund Returns_CDMC (May 2016)

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