The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance

68 Pages Posted: 4 Feb 2009 Last revised: 9 Apr 2011

See all articles by Zheng Sun

Zheng Sun

University of California, Irvine - Paul Merage School of Business

Ashley Wang

Federal Reserve Board

Lu Zheng

University of California, Irvine - Paul Merage School of Business

Date Written: February 4, 2009

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

Suggested Citation

Sun, Zheng and Wang, Ashley and Zheng, Lu, The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance (February 4, 2009). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1337424 or http://dx.doi.org/10.2139/ssrn.1337424

Zheng Sun

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

Ashley Wang (Contact Author)

Federal Reserve Board ( email )

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

Lu Zheng

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States
9498248365 (Phone)

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