Can hedge funds time global equity markets? Evidence from emerging markets

• Published date: 01 April 2016
• Author: Sean Reid,Adam L. Aiken,Osman Kilic
• Date: 01 April 2016
• DOI: http://doi.org/10.1016/j.rfe.2015.05.002

Can hedge funds time global equity markets? Evidence from

emerging markets

Adam L. Aiken

a,

⁎, Osman Kilic

b

, Sean Reid

c

a

Departmentof Finance, Elon University,United States

b

Departmentof Finance, QuinnipiacUniversity, UnitedStates

c

Departmentof Finance, IthacaCollege, United States

abstractarticle info

Availableonline 27 May 2015

JEL classification:

C2

G11

G12

G15

G23

Keywords:

Hedge funds

Markettiming

Emergingmarkets

Thispaper examines theability of global hedgefunds to time a particularlyvolatileasset class —emergingmarket

equities.In particular,we study whether or notthese funds can eithertime emerging marketsas a whole, or time

their exposures to different regions. Using both pooled and cale ndar-time approaches, we generally find no

evidence of overall timing ability.However, we do find some evidence of period-specific timing ability during

the financialcrisis and subsequent recovery.

© 2015 ElsevierInc. All rights reserved.

1. Introduction

Lightly regulated and operating with broad investment mandates,

hedge funds have many potential sources of re turns. For example,

hedgefunds may engage in strategiesas common as long-onlystock se-

lection, or they may make more complex investments related to illiquid

securities or option-like pa yoffs (e.g., Ackermann, McEnal ly, &

Ravenscraft, 1999; Agarwal & Naik, 2000, 2004; Aragon, 2007; Liang,

1999). This paperinvestigates one importantsource of performance —

the ability of hedge funds to time different markets. In particular, we

focus on the abilityof hedge funds to time different emerging markets

in changing marketenvironments.

The abilityof a manager to market time can be thoughtof as a valu-

able option. A convex relationship between a manager's beta and the

market is an indication of successful timing (Aragon & Ferson, 2006;

Merton, 1981;Henriksson & Merton, 1981). Inother words, a manager

wantshigh exposure whenthe market is increasingand low (or, ideally,

zero or negative) exposure whenthe market is decreasing.As with any

option, the valueof market timing increases as the volatility of the un-

derlyingasset increases. Because financial markets in emergingmarket

countries are stilldeveloping, volatility tends tobe significantly higher

than the volatility found in more de veloped markets (Bekaert &

Harvey, 1997). Greater volatilitycould lead to more profitable market

timing opportunities,making emerging markets an ideal environment

to test the hypothesis that hedge fund managers a dd value for their

investorsthrough timing.

The growth and volatility found in eme rging markets have not

escaped the attention of hedge fun d managers.

1

As of the end of

September2012, the hedge fund databaseHFR reports hedgefund cap-

ital in emerging marketsto be $127.8 billion, with a record number of

1085 activehedge funds.

2

These marketscan experience abruptchang-

es, though. For example,2013 was more difficult for managers, as one

large hedgefund, Brevan Howard,closed their emerging markets strat-

egy followingpoor performance.

3

Not all hedgefund managers are able

to profit fromthe volatility of the assetclass.

There are also important cross-sectional differences in the perfor-

mance of different emerging equ ity markets. These variations could

Reviewof Financial Economics29 (2016) 2–11

⁎Corresponding author at: Elon UniversityKoury Business Center 2075 Campus Box

Elon, NC 27244,United States.

1

Thereis no universally accepteddefinition of an emergingmarket. Emerging markets

are thoseeconomies that arenot as fully developedas those in the United States,Canada,

WesternEurope, and Japan. Theemerging markets that haveattracted the most attention

in the press and from investors are Brazil, Russia,India and China (the so-called “BRIC”

economies).While the BRIC emergingmarkets capture a largeportion of media coverage

and foreign investment,emerging market opportunities exist throughoutLatin America

(e.g., Argentina and Chile), East ern Europe (e.g, Poland, Hungary, the Czech Republi c

and Turkey), the Middle East (e.g., Egypt and Jordan), an d Asia (e.g., Thailand, the

Philippines, and Indonesia).

2

See“Emerging MarketsHedge Fund CapitalSurpasses Record Level”,HFR2012,http://

www.hedgefundresearch.com/pdf/pr_20121130.pdf.

3

“BrevanHoward shuts $2bn emergingmarket fund”, FinancialTimes, 2/2/14.

http://dx.doi.org/10.1016/j.rfe.2015.05.002

1058-3300/©2015 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe