Making a Bet at a Right Time : Style and Volatility Timing Abilities of Korean Equity Hedge Funds

Abstract

Korean hedge funds are institutionalized active investment strategies formed by the registered special private collective investment vehicles managed by Korean fund managers with leverage allowed up to 400% of the net asset value. Since the very first Korean equity hedge fund was launched on December 28, 2011, there are 549 different funds with varying strategies and aggregate assets under management at KRW11.5 trillion, equivalent to USD10 billion, as of July 24, 2017. Many hedge fund managers believe they are skilled at stock picking and market timing. If an active hedge fund manager is skilled in style timing, it makes sense to be particularly active in the volatile phase of the specific style factor, as the phase offers a largest risk-adjusted reward to the skill. We have investigated risk factor exposures such as size, value, and momentum in 25 survivorship bias-free individual equity hedge funds with net asset value aboveKRW50 billion out of the 549 universe to reclassify them according to their systematic style-tilting volatility, volatility-timing, and Treynor and Mazuy (1966) market timing indicators. To the best of the authors’ knowledge, it is the first research of hedge fund strategies to use daily net asset value data of individual hedge funds. We then evaluated the relationship between the three market-timing indicators to the annual excess returns of reclassified quintile hedge fund groups to identify the truly talented active style and volatility timers. Identification of the talented market and volatility timer a priori will enhance the investors’ expected risk-adjusted returns in the fund of hedge funds design and investment.