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A Nordic statistical survey supports the hunch: Motivation structure is the key to hedge fund performance

Casper Hallas and Louise Sand

Scandium Asset Management

Q2 2007

 

Choosing hedge fund managers who invest in their own fund seems like a good idea. It is not difficult to believe that managers who invest their own personal wealth in the fund they manage will strive harder to deliver the highest possible returns combined with the lowest possible risk.

Of course no two investor temperaments are exactly the same and the question of what makes for a high return with a low risk is also a question of temperament and individual horizon. The guarantee of achieving the same risk/return that your investment manager achieves for himself is not enough.

It is our view that portfolio managers who own a substantial part of the management company they work for is preferable. This is the kind of manager, who will do the best possible job,.

‘Managers who own part of the management company they work for do a better job than those who are simply employed by the company.’ This was the hypothesis that inspired a statistical survey we conducted in collaboration with Copenhagen Business School in May 2006.

The survey was based on Nordic FoHF’s and equity hedge funds with at least three years’ track record. We accept that the dataset is for the Nordic Region, consisting of 228 monthly returns reported by 19 funds, thus limits the study. It was decided that funds with less than three years’ track record should be excluded from the study, hence the limited dataset.

Performance data for the survey was reported by the funds to the Nordic hedge fund database, HedgeNordic. Information on ownership structure of the management companies was collected directly from the companies themselves.

Survey results showed that the more a portfolio manager owns of the management company, the higher the Sharpe ratio of the fund. All funds in the survey have more than three years track record (dataset of 228 monthly returns): enough to statistically conclude the following difference in Sharpe ratios between different ownership segments.
 

Figure 1

Portfolio
Manager ownership
75%-100%
50% - 75%
25%-50%
0%-25%
Sharpe ratio
3*
2.09
1.31
1.21

 

* The segment 75%-100% is benchmark to the survey results and the Sharpe ratio 3 has been chosen as a key figure. It is the difference between the different segments which has been statistically proved and not the benchmark 3.

The results of the survey support the idea of the hedge fund industry as being principally driven by individual talent. This defines the manager as a very central figure in the hedge fund business, which points to the importance of getting the motivation structure right in order for individual fund managers to deliver their best results.

This could turn out to be a future challenge to banks and financial institutions with more limited possibilities of remunerating their employees sufficiently.

A copy of the full survey results can be obtained from ls@scandiumam.com.

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