* Presentations: Midwest Finance Association (3/2019), FMA Annual Meeting (10/2018), Notre Dame (4/2018), Cincinnati (11/2018), Pitt/OSU/Penn State/CMU Finance Conference (Carnegie Mellon, 3/2018), 10th Annual Hedge Fund and Private Equity Conference (Dauphine, 1/2018)
Abstract This paper documents a new source of financial fragility and studies its interactions with common stabilization tools. Economists believe that funds report stale Net Asset Values (NAVs) when they invest in illiquid assets. This staleness creates return predictability, which in turn creates NAV-timing and fund fragility risks for open-end funds. However, because the underlying assets are illiquid, managers limit fund flows to prevent having to pay premiums or sell at discounts. A secondary consequence of limiting fund flows is that it protects against the risks created by having stale NAVs. Paradoxically, illiquidity in the underlying assets creates both the opportunity for, and the friction against, exploiting buy-and-hold investors. I show that contrary to casual intuition, using cash to buffer flows reintroduces wealth transfer risks and increases the incentive for shareholders to run.
Private Real Estate Returns and Procyclical Risk Taking
* Presentations: 3rd Annual Private Markets Research Conference (Switzerland, 2019)
This paper documents procyclical risk-taking by private real estate funds through their ground up construction (development) activities. Additionally, it addresses why these funds have procyclical development allocations. Development allocations explain both time-series and cross-sectional return variation and are one way funds achieve market risk exposure. As such, funds are disproportionately exposed to the downside of the market because of their procyclical behavior. After analyzing q-theory, reaching for yield, and capital flow pressure, I find that capital flow pressure is the primary factor influencing this behavior. Funds with larger pent up demand, disproportionately buy more liquid, safe assets in order to place capital faster. While this increases assets under management quicker, it also hurts existing investors by decreasing their market exposure at the time when it is the most beneficial.
Liquidity Transformation and Fire Sale Risks
An important question is whether a liquidity mismatch in open-ended funds leads to market fragility. This paper provides new evidence on market fragility risks by combining three novel datasets which together provide investor-level, fund-level, and asset-level details for both closed-end and open-end U.S. private real estate funds. I find that those assets sold by open-end funds during the Global Financial Crisis sold at a 10% discount compared to those assets sold by closed-end funds. In contrast, I find no statistical or economic difference between the purchase prices of open-end and closed-end funds during expansion periods.