An examination of the risk-return profile of nordic hedge funds

Abstract

The Nordic hedge fund industry has experienced a massive growth in assets under management of approximately 370% between 2005 and 2016. The increased interest for hedge funds as an investment vehicle may suggest that investors believe that Nordic hedge fund managers are able to deliver risk-adjusted excess returns. In this paper, we aim to provide a better understanding of the risk-return profile of Nordic hedge funds. Using traditional linear risk factor models, we find that Nordic hedge funds apparently creates statistical significant pre-fee alphas between 6% and 8% during the period between January 2005 and December 2016. However, empirical studies suggest that hedge fund returns exhibit significant left-tail risk and that the traditional mean-variance framework fails to capture the true risk profile of hedge funds. Furthermore, studies show that hedge fund returns resembles the returns of an uncovered index put option. This further support our belief that traditional linear risk factor models are inappropriate in order to account for the performance of hedge funds and gives motivation to apply alternative methods when studying the risk and return for Nordic hedge funds. We show that a mechanic put-writing strategy largely accounts for the net-of-fee alphas of Nordic hedge funds, but not the pre-fee alphas. However, this result hinges critically on the accuracy of the NHX reporting process. A small degree of return smoothing or presence of backfill bias or survivorship bias could potentially leave the pre-fee alphas insignificant or even negative. These findings enhances our understanding of hedge funds in aggregate, and they may provide the basis for a more sober evaluation of Nordic hedge funds as investment vehicles.