(Bloomberg) -- Sometimes it takes a crisis to bring out your best.
True in politics and marriage, and also, according to a new study, in active fund management. University of Manchester researchers Xinyu Cui and Olga Kolokolova found that during times of outflows, highly paid traders exhibit above-average stock-picking skills. Their paper is called “Do Hedge Fund Managers Work Harder Under Pressure?”
Consider an investment firm getting redemptions. When clients pull out, a money manager has to spend most of his energy selling assets to raise cash. The main finding of the study is that stocks he decides to buy while under such pressure tend to do better than average.
The higher the fund’s management fee and the looser its withdrawal requirements, the better job the manager does in picking securities during significant outflows.
It’s hard to say why, though the authors had guesses. It may have to do with reputational risk, since going under looks bad on a resume. They mentioned a 1950s-era management theory that holds that when goals are defined and the threat of punishment heightened, people work more efficiently. Less abstractly, outflows tend to reduce management fees, lowering compensation. Managers must trade better to get paid.
“To some extent, it’s easier to see talents during rough times,” Kolokolova, an associate professor at the Alliance Manchester Business School, said in a phone interview. “When you face immense pressure, you decide to go against the flow only if you have a brilliant idea or believe the stock will perform really well in the future.”
Kolokolova analyzed 499 hedge funds that issued 13F filings between the first quarter of 2002 and second quarter of 2016 and had no other investment business. After ranking quarters by size of outflows, she looked for portfolios where the manager allocated a significant part of total assets to a certain stock.
Analyzing stocks bought in those circumstances, she found their monthly return was 0.31% higher than expected over the next quarter. The effect was stronger for funds with higher management fees that have more to lose during outflows. It didn’t work the other way around: stocks that hedge fund managers aggressively buy during inflows didn’t post abnormal returns.
“It looks like when they see an outflow, they make an investment from the best possible option, when you have an inflows, you tend to invest in your existing portfolio, which tends to have good and not-too-good stocks,” Kolokolova said. At the same time, she finds that the stocks they sold during times of outflows didn’t post abnormal returns in the next months, either.
The paper, published in July, came a month after Hedge Fund Research data showed that hedge fund liquidations outnumbered launches for the third quarter in a row.
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