The Study in a Nutshell
There has always been a question of how hedge funds and asset managers make money. By exploiting a comprehensive regulatory database, a new Bank of England working paper finds that these investors have made abnormal returns in bond markets since 2011. They have done so by obtaining a competitive edge from observing other investors, responding quickly to macroeconomic news and correctly forecasting macroeconomic fundamentals.
The chart below captures the predictive power of fund managers concisely. It shows the event-time cumulative returns of the long-short portfolios (long on the top tercile and short on the bottom tercile of government bonds) sorted by daily order flows of the two investor types. We can see that hedge fund trading positively forecasts bond returns in the short run followed by a strong reversal in the subsequent month. Mutual fund order flows, on the other hand, positively forecast bond returns in the subsequent two months.
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