The Convexity and Concavity of the Flow-Performance Relationship for Hedge Funds

47 Pages Posted: 5 Oct 2013

See all articles by Guillermo Baquero

Guillermo Baquero

ESMT European School of Management and Technology

Marno Verbeek

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar

Date Written: March 15, 2013

Abstract

The shape of the flow-performance relationship in the hedge fund industry is not constant over time, but varies across market conditions. We employ a switching regression approach to explain quarterly hedge fund flows, based on two regimes where either inflows or outflows are dominating, combined with a flexible functional form for each of the equations, allowing for a nonlinear impact of past performance at different lags. For most periods, the flow-performance relationship is locally convex for a large subset of funds but becoming concave for the top three deciles of performers. The kink in the top part is more pronounced when aggregate inflows to the industry are high. This effect seems mostly driven by funds that restrict new inflows, for example due to capacity constraints or decreasing returns to scale. These results are helpful in understanding the incentives of hedge fund managers based on both performance fees and management fees.

Keywords: hedge funds, flow-performance relation, convexity, concavity, liquidity restrictions, managerial incentives

Suggested Citation

Baquero, Guillermo and Verbeek, Marno, The Convexity and Concavity of the Flow-Performance Relationship for Hedge Funds (March 15, 2013). Available at SSRN: https://ssrn.com/abstract=2336118 or http://dx.doi.org/10.2139/ssrn.2336118

Guillermo Baquero (Contact Author)

ESMT European School of Management and Technology ( email )

Schlossplatz 1
10117 Berlin
Germany

Marno Verbeek

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2790 (Phone)

HOME PAGE: http://www.rsm.nl/mverbeek

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Netspar

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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