It’s in the Numbers – How Proper Analysis of Returns can be a Crystal Ball

Background

Mangan & McColl Partners, a hedge fund manager based in Charlotte, NC announced at the end of June 2006 that its fund would be closed within a month. According to Hedge Fund Research (HFR), the fund’s stated strategy focus was on merger and special-situations arbitrage. In Figure A we show the growth of assets of the firm’s M&M Arbitrage Offshore fund. Note the speed of redemptions in 2005. According to press reports, in 2005 the fund was hit by significant redemptions, which followed highly volatile performance results and a negative report by an institutional consultant. Additionally, one of the partners was allegedly involved in inappropriate trading, an allegation that was settled with the NASD in December 2005.

Based upon these reports, Markov Processes International (MPI) performed an analysis of the fund looking for tell-tale warning signs that investors might have been able to see with proper analysis techniques. The following is the findings from that investigation.

Fund Description

M&M Arbitrage’s strategy description in HFR:

The Fund’s investment objective is to produce capital appreciation on a consistent basis by employing hedged investment strategies through a diversified portfolio of investments. The Fund’s strategy focuses on arbitrage positions concentrated in two event driven sectors: merger arbitrage and special situations arbitrage (defined as bankruptcies, corporate restructurings, corporate spin-offs, recapitalizations, high yield situations, and general value opportunities. The Fund invests announced and definitive merger transactions and broadly diversifies the portfolio over 40-60 positions. The strategy produces returns with a low volatility and a low correlation to the broader market.

Analysis

Using MPI’s proprietary Dynamic Style Analysis (DSA) methodology and the fund’s performance data we endeavored to determine the sequence of events that led to its downfall in 2005-2006. For our analysis we are using M&M Arbitrage performance data from HFR available through December 2005.