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

Two Parts Example of opportunity  Corporate governance  Sentiment Example of threat  Blame and the Asian currency crisis

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

Yale School of Management 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.

Yale School of Management

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.

Yale School of Management 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.

Yale School of Management 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?

Yale School of Management

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.

Yale School of Management 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.

Yale School of Management Values of T and g Implied by Prices of Common and Preferred Shares Expropriation level: 75% r = real rate, g(rowth rate) in %, T (expropriation date) years LKOHRTKMSNGS r % [g] [T] [2] [14] [-4] [6] [4] [6] [3] [14] [4] [19] [4] [56] 15% [g] [T] [12] [16] [6] [7] [14] [6] [13] [15] [14] [21] [14] [61]

Yale School of Management 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?

Yale School of Management 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

Yale School of Management Possible? Likely? Hedge fund scale vs. financial institutions Co-ordination vs. concealment Positive feedback?  Tech bubble stocks/large investors

Yale School of Management 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.

Yale School of Management Funds and Capitalization, 9/1993 through 9/1997

Yale School of Management Estimation Rolling correlations Changing frequency What assets/currencies?

Yale School of Management Fund Performance

Yale School of Management

Managers

Yale School of Management Managers

Yale School of Management Fund & Hsieh Study Larger number of funds: 19 Style analysis identified macro-managers  Macro  Trend  Emerging Market More events

Yale School of Management October 1987

Yale School of Management 1992 European Rate Mechanism Crisis

Yale School of Management Mexican Crisis

Yale School of Management

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.

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