Hedge Funds: Ability Persistence and Style Bias

Abstract

In this paper we analyze the persistence of the ability of hedge fund managers. Using a database of 3627 hedge funds from 1994 to 2004 we demonstrate that the ability does not persist for top performers once the strategy of the fund is correctly assessed. In order to do this we define as manager ability the difference between fund return and the return of a portfolio of hedge fund indices whose weights have been estimated minimizing the tracking error over the last 36 months. Our results are different from other contributions that measure the ability of the fund manager on the base of the investment strategy declared by the hedge fund. Using a consistent subsample of our data we demonstrate that this result is driven by a "style bias" that we define as the fact that the strategy of the fund is consistently different from the stated one.

Keywords: Hedge Funds, Selection Ability, Active Return

JEL Classification: G11, G14