Capacity Constraints in the Hedge Fund Industry Revisited

Abstract:     
I investigate the determinants of fund-of-hedge-fund performance under considerations of capacity constraints. The returns of 931 funds-of-hedge-funds are evaluated over two year periods from 1994 to 2006 by an augmented Fung and Hsieh (2004) 7-factor model. A sort on past size and percentage flows reveals that, for small and medium-sized funds, the negative flow-performance relationship is only observed in early years. Moderating the effect of flows by size in a regression framework shows that large funds suffer significantly more from inflows than smaller funds. There is some evidence that this is mostly applicable to funds that do not add value (have-alpha funds). The findings indicate that funds of all sizes face absorptive capacity constraints (i.e. incorporating new capital without loosing performance), but this is more emphasized for large funds, implying also the existence of an optimal size.

Number of Pages in PDF File: 29

Keywords: Hedge funds, capacity constraints, aplha, flows

working papers series