A Portrait of Hedge Fund Investors: Flows, Performance and Smart Money

65 Pages Posted: 24 Mar 2008

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: October 22, 2009

Abstract

We explore the flow-performance interrelation of hedge funds by separating the investment and divestment decisions of investors using a regime switching model. We report three previously undocumented features in hedge fund data. First, we find a weak inflow-performance relation at quarterly horizons together with a very steep outflow-performance relation. At annual horizons, these patterns revert. We attribute this differential response time of inflows and outflows to the combined effect of liquidity restrictions, high searching costs, and active investor monitoring. Second, consistent with the theory that performance persistence is more pronounced where money flows are least responsive, we find remarkable differences in persistence levels across horizons for the subsets of funds that experience inflows and outflows. Third, we show that limited response capacity precludes investors from investing in subsequent good performers. Conversely, investors appear to be fast and successful in de-allocating from subsequent poor performers. Our findings do not support the existence of smart money.

Keywords: hedge funds, flow-performance relation, performance persistence, liquidity restrictions, fund monitoring, searching costs, smart money

JEL Classification: G11, G23, G14, G15

Suggested Citation

Baquero, Guillermo and Verbeek, Marno, A Portrait of Hedge Fund Investors: Flows, Performance and Smart Money (October 22, 2009). EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=773384 or http://dx.doi.org/10.2139/ssrn.773384

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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