Do Funds of Hedge Funds Really Add Value? A 'Post' Crisis Analysis

Abstract:     
In spite of a somewhat disappointing performance throughout the crisis, and a series of high profile scandals, investors are showing interest in hedge funds. Still, funds of hedge funds keep on experiencing out-flows. Can this phenomenon be explained by the failure of funds of hedge funds’ managers to deliver on their promise to add value through active management, or is it symptomatic of a move toward greater disintermediation in the hedge fund industry‘ Little attention has been paid so far to the added-value, and the sources of the added-value, of funds of hedge funds. The lack of transparency that is characteristic of the hedge funds arena and makes the performance attribution exercise particularly challenging is probably an explanation. The objective of this article is to fill in the gap. We introduce to this end a return-based attribution model allowing for a full decomposition of funds of hedge funds’ performance. The results of our empirical study suggest that funds of hedge funds are funds of funds like others. Strategic Allocation turns out to be a crucial step in the investment process, in that it not only adds value over the long-term, but most importantly, it brings resilience precisely when investors need it the most. Fund Picking, on the other hand, turns out to be a double-edged sword. Overall, funds of hedge funds appear to succeed in overcoming their double fee structure, and add value across market regimes, although to varying degrees and in different forms.

Number of Pages in PDF File: 21

Keywords: Funds of Hedge Funds Performance, Performance Attribution Model, Strategic Allocation, Tactical Allocation, Fund Picking, Active Management, Added-Value, State-space Models, Kalman Filter

JEL Classification: G11

working papers series