Hedge Funds and International Opportunities and Threats

1. Hedge Funds and International Opportunities and Threats William N. Goetzmann Yale School of Management

2. Two Parts • Example of opportunity • Corporate governance • Sentiment • Example of threat • Blame and the Asian currency crisis

3. Modeling and Measuring Russian Corporate Governance: The Case of Russian Preferred and Common Shares William N. Goetzmann Matthew Spiegel Andrey Ukhov

4. Barriers to Efficiency • Expectations process flawed. • Unreasonable expectations • Poor information about benefits • The comparison process is flawed • Market prices not observed or accurate • The trading process is flawed. • Insider information vs. liquidity • Recorded prices are inaccurate.

6. Stylized facts about Russian Preferred Shares • Minimum dividend set equal to a fraction of the firm’s earnings. Typically 10%. • Minimum dividend must at least equal that paid to the common shareholders. • Protection against splits, and similar actions.

7. The Puzzle • Why do Russian preferred shares typically sell for substantially less than the common? • The preferred are guaranteed cash flows at least equal to the common. • The preferred are guaranteed at least 10% of the firm’s profits. • The preferred get the legal right to vote.

8. Voting • Preferred shareholders are allowed to vote on: . . . modifications or amendments to the Charter may affect the rights and interests of the first issue Preferred Stock owners . . . the decision has to be ratified by those owning two thirds of the Preferred Stock . . . Surgutneftegaz Charter • Other firms pool votes from the common and preferred. • Is voting really allowed?

10. Can Corporate Governance Explain the Price Discrepancy? • Paper builds three simple models of expropriation and calculates the parameters needed to explain the current observed price discrepancies. • Two cash flow perpetual growth models, with a constant discount rate. • One relative return model.

11. Model 1: Value Expropriation • At some date T the common will take some fraction α of the preferred’s value. • Free parameters: • r = interest rate • α = level of expropriation • g = growth rate • T = expropriation date. • Fix r and α to reasonable values and then see if reasonable values of g and T will fit the data.

13. Conclusions • No reasonable assumptions justify the spread. • Is Russia a place where “reasonable” assumptions make sense? • Was this an opportunity for a convergence trade? • What factors should be considered?

14. Threats: Background • Speculators in global markets • Soros’ 1992 “attack” • 1997 Asian crisis • 1998 IMF study • Small group of funds with leverage attacking. • Herding • Positive feedback -- momentum

15. Possible? Likely? • Hedge fund scale vs. financial institutions • Co-ordination vs. concealment • Positive feedback? • Tech bubble stocks/large investors

16. BGP paper • Focus on a set of major funds • Monthly data. • Estimate exposures through time. • Examine returns around crisis. • Some weekly data for two funds. • Provides better estimates.

17. Funds and Capitalization, 9/1993 through 9/1997

18. Estimation • Rolling correlations • Changing frequency • What assets/currencies?

19. Fund Performance

21. Managers

22. Managers

23. Fund & Hsieh Study • Larger number of funds: 19 • Style analysis identified macro-managers • Macro • Trend • Emerging Market • More events

24. October 1987

25. 1992 European Rate Mechanism Crisis

26. 1994-1995 Mexican Crisis

28. According to F&S… • “Hedge funds never had more than $6 Billion short position in Asia currencies” • Was this enough? • Small compared to banks: $36 billion net outflow.

29. Current/Future Issues • “Manipulation” of voting rights? • Short-selling as a threat? • Foreign investor governance “arbitrage” • Nature of arbitrage in expectations