Picking Winners? Selecting Hedge Funds for a Diversified Portfolio
64 Pages Posted: 11 Sep 2017 Last revised: 26 Mar 2019
Date Written: March 21, 2019
This paper studies whether the performance of a stock/bond portfolio is improved by an allocation to hedge funds selected using a wide array of predictors from existing research. Performance is assessed using standard metrics and a novel simulation procedure that permits probabilistic inference. The benefit realized by investors deteriorates after reversing upward biases in returns and constraining the number of hedge funds selected. Even after controlling for these issues, seven of the predictors reliably select funds that raise the Sharpe ratio of a stock/bond portfolio over the full 1997 – 2016 sample. Sub-sample analysis shows the benefit disappears after 2007.
Keywords: hedge fund performance, skill, timing, incentives, systematic risk, tail risk
JEL Classification: G11, G12, G14, C31
Suggested Citation: Suggested Citation