Returns to Active Management: The Case of Hedge Funds

Abstract

Do more active hedge fund managing strategies generate higher returns than the less active ones? We develop a novel approach to measuring activeness for hedge funds by estimating the dynamics of risk exposure of a large sample of live and dead equity long-short funds. We find that higher activeness is positively correlated with raw excess returns, but not with risk-adjusted returns. Furthermore, the relationship between risk-adjusted returns and activeness is likely non-linear and some specifications suggest evidence of a negative association. The results suggest that a strategy that exposes hedge funds to more frequent changes in market risk exposures comes at the expense of higher risks that are not necessarily justified by better performance.

Keywords: Hedge Funds, Fama-French, Active Management, Dynamic Trading

JEL Classification: G11, G12, G14, G23