Skeptical about your hedge fund manager’s skill? You should take a look at their short-selling records, research shows.
From a study of 53 hedge fund firms and their trades from
1999 to 2011, researchers from the University of Illinois at Urbana-Champaign
and consultant Brattle Group found hedge fund managers gained higher profits on
short sales than non-hedge funds.
Short sales that were covered—or repurchased—within five
trading days earned an average return of 14 basis points per day, or 35% per
In contrast, non-hedge fund institutional investors lost an
average of 10.8 basis points per day for short sales also covered within five
“Hedge fund short-selling abnormal performance is
persistent, consistent with it being due to skill, but that of non-hedge funds
is not,” wrote University of Illinois’ Jaewon Choi, Neil Pearson, and Brattle’s
In fact, funds that scored in the highest quintile on
previous short trades continued to outperform in future quarters.
This persistent outperformance could be due to “informed
trading” and “private information”, the authors continued.
“Hedge fund short positions opened in a short window prior
to earnings announcements predict negative earnings surprises, and their short
trades that are open during earnings announcement and covered within five trade
dates… are profitable,” Choi, Pearson, and Sandy said.
Furthermore, hedge fund managers profited from liquidity
provisions, while non-hedge funds saw no such correlation.
The researchers found their short sales kept longer than
five days averaged nearly zero in returns while non-hedge fund investors earned
2.6 basis points on trades repurchased within one to three months.
Read the full paper “A First
Glimpse into the Short Side of Hedge Funds”.
Case Against Hedge Fund Managers