Hedge fund managers tell you when they underperform

Ok, they won’t tell you by sending out an investor letter, but they do tell the SEC, just not in so many words. Unfortunately, that information is private, which makes me feel a bit cheated.

Since 2011, hedge funds in the US with at least $1.5bn in gross assets managed have to file form PF quarterly with the SEC and provide additional about their risk metrics and other factors. Smaller hedge funds have to file form PF only annually and don’t have to disclose additional metrics.

The responses to form PF are confidential but a team from the Federal Reserve were allowed to analyse it and that makes for interesting reading. In Form PF, hedge funds have to estimate how they think their assets would change if equity markets rise or fall by 5% or 20%. This sensitivity analysis allows one to calculate an estimate beta of the hedge fund to the equity market.

Look at the chart below which shows the expected excess return reported by hedge funds in Form PF (based on the implied beta from the sensitivity analysis) and the subsequent realised excess return of these funds. As you can see, there is a close relationship between what hedge funds expect will happen to their funds and the subsequently realised excess returns.

Predictive power of manager perceived beta

Source: Barth et al. (2024)

Admittedly, these are short-term returns over a quarter, but I wonder if there is also some longer-term predictive information in that data. In any case, if anyone who reads this is a major institutional investor in hedge funds, I think this research makes a case for either lobbying the SEC to disclose this information in aggregate form or lobbying the hedge funds you invest in to disclose this information voluntarily to their investors. Either way here is really useful information that I would like to see published regularly.