Man vs. Machine: Comparing Discretionary and Systematic Hedge Fund Performance

Abstract

We analyse and contrast the performance of discretionary and systematic hedge funds. Systematic funds use strategies that are rules-based, with little or no daily intervention by humans. In our experience, some large allocators shy away from systematic hedge funds altogether. A possible explanation for this is what the psychology literature calls “algorithm aversion”. However, we find no empirical basis for such an aversion. For the period 1996-2014, systematic and discretionary manager performance is similar, after adjusting for volatility and factor exposures, i.e., in terms of their appraisal ratio. It is sometimes claimed that systematic funds’ returns have a greater exposure to well-known risk factors. We find, however, that for discretionary funds (in the aggregate) more of the average return and the volatility of returns can be explained by risk factors.

Keywords: Hedge Funds, Systematic Trading, Discretionary Trading, Alpha, Market Efficiency, Risk Factors, Asset Allocation, Algorithm Aversion

JEL Classification: E32, E44, G11, G12, G14