Returns to Active Management: The Case of Hedge Funds

31 Pages Posted: 23 Aug 2014

See all articles by Maziar Kazemi

Maziar Kazemi

Board of Governors of the Federal Reserve System

Ergys Islamaj

Vassar College - Department of Economics

Date Written: August 19, 2014

Abstract

Do more active hedge fund managers generate higher returns than their less active peers? We attempt to answer this question. Using Kalman Filter techniques, we estimate the risk exposure dynamics of a large sample of live and dead equity long-short hedge funds. These estimates are then used to develop a measure of activeness for each hedge fund. Our results show that there exists a nonlinear relationship between activeness and performance. Using raw returns as a measure of performance, it is found that more active funds outperform the less active ones. However, when risk adjusted returns are used to measure performance, we find the opposite results; that is, activeness is inversely related to returns. Still, we find that a few very active managers outperform the moderately active funds and generate higher returns. We conclude that the most active managers use their skills to manage the riskiness of their portfolios and are, therefore, able to provide higher risk adjusted returns. Finally, we find that compared to the least active managers, the most active managers are less homogeneous and, therefore, due diligence is far more important when selecting an active manager.

Keywords: hedge funds, Fama-French, active management, dynamic trading

JEL Classification: G11, G12, G14, G23

Suggested Citation

Kazemi, Maziar and Islamaj, Ergys, Returns to Active Management: The Case of Hedge Funds (August 19, 2014). FRB International Finance Discussion Paper No. 1112, Available at SSRN: https://ssrn.com/abstract=2484735 or http://dx.doi.org/10.2139/ssrn.2484735

Maziar Kazemi (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Ergys Islamaj

Vassar College - Department of Economics ( email )

124 Raymond Avenue
Poughkeepsie, NY 12604
United States

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