Liquidity Costs, Return Smoothing, and Investor Flows : Evidence from a Separate Account Platform

Using a new dataset of hedge fund returns from separate accounts on the Lyxor platform, we examine the costs and advantages of the greater liquidity of the Lyxor platform verses those of the associated main hedge funds. Lyxor accounts are traded pari passu with the main fund but provide superior liquidity, third-party reporting, and low funding requirements. Overall, the greater liquidity of the separate account platform reduces the performance of Lyxor accounts by 2.2% annually relative to the associated main hedge fund. The fact that returns are calculated by a third party allows us to estimate the manager discretion (i.e, main-fund specific) portion of hedge fund return smoothing. We estimate that 24% of reported main hedge fund autocorrelation is due to manager discretion in return reporting. We also find strong evidence that investors on the Lyxor platform utilize the ease of liquidation and investment on the platform to chase monthly performance, while no such effect is present in the main funds