Working Paper: CEPR ID: DP5565
Authors: William Fung; David A. Hsieh; Narayan Naik; Tarun Ramadorai
Abstract: We use a comprehensive dataset of Funds-of-Hedge-Funds (FoFs) to investigate performance, risk and capital formation in the hedge fund industry over the past ten years. We confirm the finding of high systematic risk exposures in FoF returns. We divide up the past ten years into three distinct subperiods and demonstrate that the average FoF has only delivered alpha in the short second period from October 1998 to March 2000. In the cross section of FoFs, however, we are able to identify FoFs capable of delivering persistent alpha. We find that these more successful hedge funds experience far greater (and steadier) capital inflows than their less fortunate counterparts. Berk and Green's (2004) rational model of active portfolio management implies that diminishing returns to scale combined with the inflow of new capital leads to the erosion of superior performance over time. In keeping with this implication, we provide evidence that even successful hedge funds have experienced a recent, dramatic decline in risk-adjusted performance.
Keywords: alpha; factor models; flow; funds-of-hedge-funds; hedge funds; performance
JEL Codes: G11; G12; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| successful funds (positive alpha) (G23) | greater capital inflows (F32) |
| greater capital inflows (F32) | erosion of superior performance (D29) |
| diminishing returns to scale + inflow of new capital (D25) | erosion of superior performance (D29) |
| persistent alpha (C41) | steady capital inflows (F32) |
| zero or negative alpha (C69) | zero or negative inflows (F21) |
| specific market period (October 1998 to March 2000) (G14) | statistically significant alpha (C46) |
| other market periods (G14) | no alpha (Y70) |