Alpha or Beta in the Eye of the Beholder: What Drives Hedge Fund Flows?

CAPM alpha explains hedge fund flows better than alphas from more sophisticated models. This suggests that investors pool together sophisticated model alpha with returns from exposures to traditional (except for the market) and exotic risks. We decompose performance into traditional and exotic risk components and find that while investors chase both components, they place greater relative emphasis on returns associated with exotic risk exposures that can only be obtained through hedge funds. However, we find little evidence of persistence in performance from traditional or exotic risks, which cautions against investors’ practice of seeking out risk exposures following periods of recent success.

Keywords: Hedge Funds, Investor Flows, Alpha, Alternative Beta, Exotic Beta

JEL Classification: G11, G20

Suggested Citation: Suggested Citation

Agarwal, Vikas and Green, T. Clifton and Ren, Honglin, Alpha or Beta in the Eye of the Beholder: What Drives Hedge Fund Flows? (3 2017). Journal of Financial Economics (JFE), Forthcoming, Hong Kong University of Science & Technology, HKUST Finance Symposium 2016: Active Investing and Arbitrage Capital, Available at SSRN: https://ssrn.com/abstract=2641975