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Return Smoothing, Liquidity Costs, and Investor Flows: Evidence from a Separate Account Platform

Author

Listed:
  • Charles Cao

    (Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802)

  • Grant Farnsworth

    (Neeley School of Business, Texas Christian University, Fort Worth, Texas 76109; and Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802)

  • Bing Liang

    (Isenberg School of Management, University of Massachusetts Amherst, Amherst, Massachusetts 01103)

  • Andrew W. Lo

    (Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts 02142)

Abstract

We use a new hedge fund data set from a separate account platform to examine (1) how much of hedge fund return smoothing is due to main fund–specific factors, such as managerial reporting discretion and (2) the costs of removing hedge fund share restrictions. These accounts trade pari passu with matching hedge funds but feature third-party reporting and permissive share restrictions. We use these properties to estimate that 33% of reported smoothing is due to managerial reporting methods. The platform’s fund-level liquidity is associated with a 1.7% performance reduction on an annual basis. Investor flows chase monthly past performance on the platform but not in the associated funds.

Suggested Citation

  • Charles Cao & Grant Farnsworth & Bing Liang & Andrew W. Lo, 2017. "Return Smoothing, Liquidity Costs, and Investor Flows: Evidence from a Separate Account Platform," Management Science, INFORMS, vol. 63(7), pages 2233-2250, July.
    • Handle: RePEc:inm:ormnsc:v:63:y:2017:i:7:p:2233-2250
    DOI: 10.1287/mnsc.2015.2401
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    References listed on IDEAS

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    Cited by:

    1. Kim, Tae Yoon & Lee, Hee Soo, 2018. "Does your hedge fund manager smooth returns intentionally or inadvertently?," Journal of Banking & Finance, Elsevier, vol. 93(C), pages 33-40.

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