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Alternative Investments - February 02, 2005

An interview with Vikas Agarwal, Research Associate with the Edhec Risk and Asset Management Research Centre

Vikas Agarwal is Assistant Professor of Finance at Georgia State University and Research Associate with the Edhec Risk and Asset Management Research Centre. He has a PhD in Finance from London Business School and has published numerous papers and articles in the field of hedge funds.

Vikas Agarwal

There is currently a debate in the industry on the scalability of hedge fund investments - as the volumes of investment grow, many claim that alpha is being diluted. What is your view on the subject? Do you believe that returns were better when hedge funds worked on a smaller scale and that returns will now begin to revert to the mean?

Vikas Agarwal: Most hedge fund strategies aim to exploit quasi-arbitrage opportunities in niche financial markets where potentially, there can be capacity constraints. For example, where the amount of money that risk arbitrage managers can invest should depend on the level of M&A activity, there is a scale issue for certain strategies. However, one can think of counter-examples here, such as long-short equity strategy, which may not face similar capacity constraints. In a research paper that I am writing with Prof. Narayan Naik at London Business School and Prof. Naveen Daniel at Georgia State University, we find evidence of decreasing returns to scale where funds with larger money flows in the recent past are associated with poorer future performance after controlling for strategy effects. So, overall, I think that the issue of scalability is a genuine concern for the hedge fund industry.

There is also much talk currently on passive replication of hedge funds. Is it realistic to think that passive replication is possible in the hedge fund universe and that one could replicate the returns without requiring the presence of a manager?

Vikas Agarwal: There has been much academic and practitioner research on the passive replication of different hedge fund strategies. Considering the dynamic nature of these strategies and the breadth of financial markets that they span, this is certainly a challenging exercise. In one of my research papers with Prof. Narayan Naik (London Business School), we show that one can achieve some success in using option-based factors along with the conventional risk factors such as market, credit risk, size, etc. to generically explain the returns of equity-oriented hedge fund strategies. In another research paper with Prof. Bill Fung and Prof. Narayan Naik (both London Business School) and Yee Cheng Loon (Georgia State University), we are able to replicate the convertible arbitrage strategy to some extent. Other researchers have been able to replicate some other hedge fund stategies, such as Fung & Hsieh replicating the trend following, equity long-short and fixed income arbitrage strategies, Mitchell & Pulvino replicating the risk arbitrage strategy and Gatev, Goetzmann and Rouwenhorst replicating the pairs trading strategy. So, it seems that we are getting closer to financially engineering the different hedge fund strategies. However, I should definitely point out that all these attempts are still not able to explain everything and that there is a significant amount of active risk involved in hedge fund strategies, which can be thought of as manager risk.

What do you think of the quality of hedge fund indices in general? For example, they are often accused of not truly representing the hedge fund universe that they are supposed to represent?

Vikas Agarwal: I have not done any research on hedge fund indices myself but I am aware that Edhec has many in-house experts such as Noël Amenc, Lionel Martellini and François-Serge L'Habitant, who have done a lot of rigourous work on this subject. Their results suggest that none of the hedge fund indices on their own truly represents the hedge fund universe and hence, one needs to extract information from all of them and construct more representative hedge fund indices, which is something that Edhec has done, and which I believe has rendered a great service to the hedge fund community.

What are your research plans for the future? What areas are you intending to focus on?

Vikas Agarwal: I began research on hedge funds as a PhD student at London Business School in 1997. So, I have spent a long time - 7 years - undertaking research in this fascinating area. Believe it or not, I continue to be just as fascinated, if not more so, with hedge funds. So, I can see myself producing further academic research on hedge funds in the future. Currently, I am working on a number of projects related to hedge funds, such as the incidence of hedge fund frauds and regulatory issues, the risk-taking behaviour of hedge fund managers, the passive replication of hedge fund strategies, and the unique organisational features of hedge funds and their implications for risk-return trade-offs and investor behaviour in the hedge fund industry.

You are a research associate with the Edhec Risk and Asset Management Research Centre. What motivated you to join the centre as a research associate?

Vikas Agarwal: As I mentioned earlier, I believe that the Edhec Risk and Asset Management Research Centre is engaged in undertaking quality, cutting-edge research on hedge funds with the assistance of many talented people. I consider it to be a great opportunity for me to be able to share my own research and thoughts with others at the centre, and help in achieving our common goals of serving the hedge fund community at large.

Vikas Agarwal's Published Papers:

  1. Risks and Portfolio Decisions involving Hedge Funds (with Narayan Y. Naik), Review of Financial Studies, 2004, Volume 17, Number 1, pp. 63-98

  2. Multi-Period Performance Persistence Analysis of Hedge Funds (with Narayan Y. Naik), Journal of Financial and Quantitative Analysis, 2000, Volume 35, Number 3, pp. 327-342

  3. Generalized Style Analysis of Hedge Funds (with Narayan Y. Naik), Journal of Asset Management, 2000, Volume 1, Number 1, pp. 93-109

  4. On taking the "Alternative Route": Risks, Rewards, and Performance Persistence of Hedge funds (with Narayan Y. Naik), Journal of Alternative Investments, Spring 2000, Vol. 2, Number 4, pp. 6-23
SSRN Versions of Vikas Agarwal's Papers:
  1. Risks and Portfolio Decisions Involving Hedge Funds, Review of Financial Studies, Forthcoming, Vikas Agarwal and Narayan Y. Naik, Georgia State University and London Business School - Institute of Finance and Accounting

  2. Multi-Period Performance Persistence Analysis of Hedge Funds, Vikas Agarwal and Narayan Y. Naik, Georgia State University and London Business School - Institute of Finance and Accounting

  3. On Taking the "Alternative Route": Risks, Rewards, Style and Performance Persistence of Hedge Funds, Vikas Agarwal and Narayan Y. Naik, Georgia State University and London Business School - Institute of Finance and Accounting

  4. Performance Evaluation of Hedge Funds with Option-Based and Buy-and-Hold Strategies, Vikas Agarwal and Narayan Y. Naik, Georgia State University and London Business School - Institute of Finance and Accounting

  5. Flows, Performance, and Managerial Incentives in Hedge Funds, Vikas Agarwal , Naveen D. Daniel and Narayan Y. Naik, Georgia State University, Georgia State University - Department of Finance and London Business School - Institute of Finance and Accounting

  6. Intertemporal Variation in the Performance of Hedge Funds Employing a Contingent-Claim-Based Benchmark, Vikas Agarwal, Georgia State University

  7. Multi-Period Performance Persistence Analysis of Hedge Funds, Journal of Financial and Quantitative Analysis, Vol. 35, No. 3, September 2000, Vikas Agarwal and Narayan Y. Naik, Georgia State University and London Business School - Institute of Finance and Accounting