Hedge Funds: Performance, Risk and Capital Formation

33 Pages Posted: 27 Jun 2006

See all articles by William Fung

William Fung

PI Asset Management, LLC

David A. Hsieh

Duke University - Fuqua School of Business; Duke University - Department of Economics; National Bureau of Economic Research (NBER)

T. Ramadorai

Imperial College London; Centre for Economic Policy Research (CEPR)

Narayan Y. Naik

London Business School - Institute of Finance and Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: March 2006

Abstract

We use a comprehensive dataset of Funds-of-Hedge-Funds (FoFs) to investigate performance, risk and capital formation in the hedge fund industry over the past ten years. We confirm the finding of high systematic risk exposures in FoF returns. We divide up the past ten years into three distinct subperiods and demonstrate that the average FoF has only delivered alpha in the short second period from October 1998 to March 2000. In the cross section of FoFs, however, we are able to identify FoFs capable of delivering persistent alpha. We find that these more successful hedge funds experience far greater (and steadier) capital inflows than their less fortunate counterparts. Berk and Green's (2004) rational model of active portfolio management implies that diminishing returns to scale combined with the inflow of new capital leads to the erosion of superior performance over time. In keeping with this implication, we provide evidence that even successful hedge funds have experienced a recent, dramatic decline in risk-adjusted performance.

Keywords: Hedge funds, performance, alpha, factor models, flow, funds-of-hedge funds

JEL Classification: G11, G12, G23

Suggested Citation

Fung, William (Bill) and Hsieh, David Arthur and Ramadorai, Tarun and Naik, Narayan Y., Hedge Funds: Performance, Risk and Capital Formation (March 2006). CEPR Discussion Paper No. 5565. Available at SSRN: https://ssrn.com/abstract=912465

William (Bill) Fung

PI Asset Management, LLC ( email )

79 Wellington Street West
Suite 3500
Toronto, Ontario M5K 1K7
Canada

David Arthur Hsieh

Duke University - Fuqua School of Business ( email )

Department of Finance
Box 90120
Durham, NC 27708-0120
United States
919-660-7779 (Phone)
919-660-7961 (Fax)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tarun Ramadorai (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

HOME PAGE: http://www.tarunramadorai.com

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Narayan Y. Naik

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 724 3317 (Fax)

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