How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings

Abstract

We provide the first comprehensive examination of hedge funds' long-equity positions and the performance of these stock holdings. Compared to mutual funds, hedge funds have higher turnover, weights further away from the market portfolio, prefer smaller opaque securities, and their trading moves slightly in front of mutual funds. However, despite their active trading nature, aggregate hedge fund trading and holdings are not beneficial in predicting the cross-section of future stock returns, indicating that on average hedge fund long-equity positions are not informed. Decomposing returns into three components, we find some weak statistical evidence on a value-weighted basis that hedge funds are better at stock picking (1.32 percent per year) than mutual funds, but this result is driven by tech stock holdings in 1999 and 2000 and becomes statistically insignificant if looking at equal-weighted performance or with price-to-sales benchmarks. The sector timing ability and average style choices of hedge funds are no better than that of mutual funds. Additionally, we fail to find differential ability between hedge funds. Overall, our study raises serious questions about the proficiency of hedge fund managers.

Keywords: Hedge Fund Holdings, Performance evaluation, Performance persistence

JEL Classification: G23, G29