The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance

Abstract

Basic economic principles suggest that a well-known trading strategy offers little economic profit. In this paper, we investigate whether skilled hedge fund managers are more likely to pursue unique investment strategies that result in superior performance. We propose a measure of the distinctiveness of a fund’s investment strategy based on historical fund return data. Specifically, we examine the extent to which a fund’s returns differ from those of its peer funds. We call the measure the “Strategy Distinctiveness Index” (SDI). The higher the SDI, the more distinctive is a fund’s strategy. We document substantial cross-sectional variations as well as strong persistence over time in funds’ SDI. Our main result indicates that, on average, a higher SDI is associated with better subsequent performance. Funds in the highest SDI quintile significantly outperform funds in the lowest quintile by about 3.5% in the subsequent year after adjusting for risk.

Keywords: Strategy Distinctiveness, Hedge Fund

JEL Classification: G10, G20