The OFR issued a research paper, “Investor Concentration, Flows, and Cash Holdings: Evidence from Hedge Funds.” The working paper says, some hedge funds have a few large investors. Such a concentrated investor base can make a fund vulnerable to unexpected requests for large redemptions. The paper shows that U.S. hedge funds in part account for that risk by holding more cash and liquid assets. These holdings help funds accommodate large outflows, but also result in lower risk-adjusted returns.

A related blog by OFR Deputy Director for Research and Analysis Stacey Schreft asks, “How Do Hedge Funds With a Few Big Investors Manage the Risk of Runs?” In the blog, she says, the authors find that hedge funds with a concentrated investor base tend to hold more cash and liquid assets. These measures help the funds accommodate large, unexpected outflows. However, the added liquidity means these funds generate significantly lower risk-adjusted returns than hedge funds with more investors.

The findings are informative for policymakers by showing that hedge funds act to mitigate the risk their small investor base can pose to financial stability.

The blog can be found here.

The research paper can be found here.

The OFR home page is at: https://www.financialresearch.gov/.