On the Relative Performance of Multi-Strategy and Funds of Hedge Funds

Journal of Investment Management, Vol. 5, No. 3, Third Quarter 2007

Posted: 7 May 2007 Last revised: 3 Aug 2011

See all articles by Vikas Agarwal

Vikas Agarwal

Georgia State University; University of Cologne - Centre for Financial Research (CFR)

Jayant R. Kale

Georgia State University

Date Written: 2007


Recently, there has been explosive growth in two products from the hedge fund industry - multi-strategy (MS) funds and funds of hedge funds (FOFs), both of which offer diversification across different hedge fund strategies. In well-functioning markets, both investment vehicles should offer similar returns. Over the period 1994 - 2004, we find that MS funds outperform FOFs on a risk-adjusted basis by 2.6% to 4.8% per year on gross-of-fee and by 3.0% to 3.6% per year on net-of-fee basis. The superior performance of MS funds continues to hold even when we control for fund characteristics such as size, management and incentive fees, and other conventional control variables. Since FOFs underperform MS funds on both net- and gross-of-fee basis, their underperformance cannot be entirely explained by their double-layered fee structure. The question then is how MS funds and FOFs can co-exist in equilibrium in view of the significant differential in performance? We suggest that investors perceive greater agency risk in the structure of MS funds relative to FOFs and therefore require greater compensation for investing in MS funds. MS funds are able to generate these higher returns because they possess greater investment flexibility and are able to invest in less liquid assets. It is also possible that MS funds generate greater returns because managers with "better" ability self-select into joining MS funds and the competition among MS funds results in the rents from superior ability being passed on to the investors in the form of better returns. Controlling for the differences in agency risk, flexibility, and fee structure between MS funds and FOFs, our results suggest that self-selection by managers with superior ability in MS funds may be the driving force behind their superior performance relative to FOFs.

Keywords: Multistrategy hedge funds, Funds of hedge funds, Performance, Fees, Agency risk, Investment flexibility

JEL Classification: G11, G12

Suggested Citation

Agarwal, Vikas and Kale, Jayant Raghunath, On the Relative Performance of Multi-Strategy and Funds of Hedge Funds (2007). Journal of Investment Management, Vol. 5, No. 3, Third Quarter 2007, Available at SSRN: https://ssrn.com/abstract=984660

Vikas Agarwal (Contact Author)

Georgia State University ( email )

35 Broad Street,
Suite 1221
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
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HOME PAGE: http://vagarwal.gsucreate.org/

University of Cologne - Centre for Financial Research (CFR) ( email )

Albertus-Magnus Platz
Cologne, 50923

Jayant Raghunath Kale

Georgia State University ( email )

Robinson College of Business
University Plaza
Atlanta, GA 30303-3083
United States
404-413-7345 (Phone)
404-413-7312 (Fax)

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