A Cycle of Flows, Price Pressure, and Hedge Fund Returns (Podcast)

The enormous growth in hedge fund assets began in the late 1990s and has continued up to the present. At the same time, academic research has focused on the flow-driven price impacts on financial assets but has not focused on burgeoning hedge fund assets. Katja Ahoniemi and coauthor Petri Jylhä seek to correct that oversight with their recent Financial Analysts Journal article, “Flows, Price Pressure, and Hedge Fund Returns,” published in the September/October 2014 issue.

We got the chance to speak with Ahoniemi about the implications of her research.

In their research, Ahoniemi and Jylhä explored how capital flows affect hedge fund returns. They found that funds with high inflows outperform funds with high outflows during the month of the flows, which generates a cycle: Flows exert price pressure, which induces more flows, and these flows trigger further price pressure.

Importantly, their research has clear and practical implications for evaluating the performance of hedge funds. “There is a lot of attention paid to the skill of hedge fund managers,” Ahoniemi said. “And when analysts look at hedge funds . . . they may be interested in the risk exposures of a fund, the pure skill of a manager, but actually, we’re saying that flows could also be an additional driver to performance.”

Furthermore, managerial compensation can be affected by the cycle the authors discovered. “On a very practical level, if managerial compensation of hedge fund managers is tied to fund performance, as it normally is, then there could potentially be implications from these results [to the effect] that flows are affecting the returns in the short term,” Ahoniemi said. “And as our results indicate, these flow impacts on returns take a very long time to revert.”

To learn more about the results of this research, listen to the interview above or download the MP3.

CFA Institute members can read the full article on the Publications website.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.