Dr. Vikas Agarwal's hedge fund research covers behavior, and charitable contributions. Future studies focus on distressed mega funds and tax effects.
6 min read | May 2, 2023
Dr. Vikas Agarwal is a Bank of America Distinguished Chair and Professor of Finance at Georgia State University. He’s recognized for decades of excellence, with prize winning papers, in Hedge Fund research. He shares his thoughts on characteristics of hedge fund managers and their intriguing behavioral science aspects.
Dr. Agarwal, could you please take us through a bit of your background and how you came to research hedge funds?
I am currently a Distinguished University Professor of the University System of Georgia & Bank of America Distinguished Chair and Professor of Finance at the J. Mack Robinson College of Business at Georgia State University (GSU). I completed my doctoral studies at the London Business School (LBS) in 2001 before joining GSU.
During my doctoral studies, I started doing research on mutual funds and had little idea about what hedge funds are. It was an interesting coincidence that one of the alums of LBS, Patrick Fauchier, approached my PhD advisor, Professor Narayan Y. Naik, with data on hedge funds to see if he had any student that was interested in doing research on hedge funds. When Narayan shared this opportunity with me, I had not even heard of hedge funds and told him that I would read and get back to him. As I learned more about hedge funds, I found out that there was little academic research on hedge funds at the time. I found hedge funds to be much more interesting and challenging to study considering the complexity of their investment strategies, different compensation structure, and liquidity constraints for the investors among other things. I ended up working on my first paper on hedge funds in 1997 and Long Term Capital Management debacle happened in August 1998. Everyone in the world wanted to know more about hedge funds at that point and I was there at the right place at the right time!
Which hedge fund strategies are easiest or hardest to analyze for your research?
To begin with, any hedge fund strategy is challenging to analyze because of limited disclosure of their portfolio positions. As a result, academic research has attempted to “reverse engineer” different trading strategies by replicating them through positions in the underlying securities. This approach has been useful in analyzing popular hedge fund strategies such as merger arbitrage, trend following, fixed income arbitrage, pairs trading, and convertible arbitrage. However, when there is either not enough information even about the securities involved in a trading strategy or the strategy does not have standard rule (e.g., long convertible bond and short equity in the case of convertible arbitrage strategy), it becomes difficult to analyze such strategies. Examples of such strategies would include statistical arbitrage, high frequency trading, and macro.
What are the merits of analyzing the qualitative/behavioral factors of a hedge fund in risk reward research?
The primary benefit of analyzing qualitative/behavioral factors to understand the risks and rewards of hedge funds is that it nicely complements the quantitative analyses in helping with manager selection. Ultimately, hedge fund managers are human beings whose actions and origins can provide useful information about their performance and risk-taking behavior.
To what extent is technology, for example ChatGPT/AI, changing the landscape of hedge fund research?
Artificial intelligence tools such as ChatGPT can help hedge funds in their investment process. At the same time, academic research can use these tools to study the return generating process and performance attribution.
What behavioral psychology characteristics of hedge fund founders have you observed?
My research has examined the charitable contributions and naming strategy of hedge funds. Specifically, I find that personal donations by hedge fund managers are not always for altruism and can be strategically used by underperforming managers to attract flows into their funds. Investors who do direct more capital to funds whose managers donate do not benefit from better performance. Moving to the naming strategy, I have examined eponymous funds where the founder managers name the funds after themselves. I find that these funds do not perform better than their non-eponymous peers but managers of eponymous funds behave more ethically as reflected in lower operational risk and lesser flags of financial misconduct or fraudulent behavior.
Are there distinguishing characteristics to eponymous hedge funds?
Yes, very much so. As I stated above, managers of eponymous funds are more trustworthy, a quality that investors value. I find that eponymous funds receive higher flows when they perform well compared to their non-eponymous peers. Offsetting these benefits, eponymous funds also face higher costs when managers of eponymous funds breach investor trust by committing regulatory violations. In such instances, net flows into eponymous funds are lower than that into non-eponymous peers even after performing well.
What has your research observed about hedge funds and their charitable contributions?
Adding to what I mentioned before, I find that investors punish fund managers that make charitable contributions if their poor performance persists after such contributions. Moreover, I find that certain types of donations, those that are one-off or event based (e.g., fundraising gala), are more likely to be strategic. Moreover, digging more into the size of the funds and size of donations, I find that benefits from donations are not scalable. Only small funds with large donations are rewarded with more flows after donations.
What is the least known characteristic of hedge funds from your research?
There is so much that we don’t know about hedge funds. As I alluded to before, we do not have granular information about the different tools that hedge funds use in their investment strategies. These include tools such as short selling, derivatives, and leverage.
Was there any disparate impact or blowback on hedge fund managers from the pandemic?
I haven’t seen any research specifically on the impact of the pandemic on hedge fund managers. One study shows that performance of female hedge fund managers was adversely affected because of greater childcare responsibilities when schools and childcare centers were closed.
What future hedge fund studies and topics excite you going forward?
I am currently working on several hedge fund studies that I am quite excited about. First of these looks at the costs borne by mega hedge funds when they are financially distressed. I find that other hedge funds and mutual funds are able to benefit from the financial distress of mega hedge funds either by shorting the securities in which mega hedge funds have a long position or offloading the same long positions before the mega funds liquidate. In another study, I show that changes in personal income tax rates can adversely affect hedge fund performance because fund managers have less incentives to work when they face higher taxes especially those managers that have a greater cultural preference for leisure. I find that managers exert less effort in information acquisition and processing. However, incentives from the sensitivity of flows to past performance, compensation contract, and co-ownership in the fund can help mitigate the disincentives to work when taxes go up.