Hedge Fund Flows and Performance Streaks: How Investors Weigh Information

90 Pages Posted: 25 Jan 2015 Last revised: 4 Feb 2015

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: January 28, 2015

Abstract

We examine the relative weights hedge fund investors attach to past information in the fund selection process. The weighting scheme appears inconsistent with the one of econometric forecast models that predict fund returns, alphas or Sharpe ratios. In particular, investor flows are highly sensitive to performance streaks despite their limited predictive power regarding fund performance. Further, allocations based on forecast models' out-of-sample predictions beat investors allocations by a significant margin, which suggests that the latter are suboptimal and reflect overreaction to certain types of information. Our findings do not support the notion that sophisticated investors have superior information or superior information processing abilities.

Keywords: Hedge funds, money flows, extrapolative expectations, law of small numbers, performance streaks, relative weights, smart money

JEL Classification: G11, G12, G14, G23

Suggested Citation

Baquero, Guillermo and Verbeek, Marno, Hedge Fund Flows and Performance Streaks: How Investors Weigh Information (January 28, 2015). ESMT Working Paper No. 15-01. Available at SSRN: https://ssrn.com/abstract=2554523 or http://dx.doi.org/10.2139/ssrn.2554523

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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