Hedge Fund Innovation

Abstract

We document cycles of innovation fueled by early-mover advantages in the hedge-fund industry. Our method involves clustering hedge funds based on their self-reported strategic risk profile at inception. The 'innovative funds', compared with their 'imitators', survive twice as long while having—at 0.76%—three times higher monthly alphas. The outperformance is persistent and robust to fund-family effects, common biases and possible restatements of the reported data. As an aspect of 'skill', innovativeness is associated with higher incentive fees. A feasible investment strategy based on fund innovativeness generates a significant alpha of 0.58% per month.

Keywords: hedge funds, innovation, followers, excess returns, institutional design, first-mover advantage

JEL Classification: G15, G23