Abstract - Hedge Funds: Performance, Risk and Capital Formation (with W. Fung, D. Hsieh, and N. Naik)
There has been an explosion of interest in and investment into hedge funds over the past decade. In this paper, we use a comprehensive dataset of funds-of-hedge-funds to investigate the performance, risks, and process of capital formation of these vehicles. We find, contrary to popular belief, that fund-of-hedge-fund returns are a (time-varying) mix of systematic risk exposures (beta bets) and absolute returns (alpha), with the preponderance of returns coming from the beta bets. Second, we find evidence that the magnitude of fund-of-hedge-fund alpha is sensitive to market conditions, and that alpha appears to have declined since the beginning of our sample period. Third, the behavior of capital flows into funds-of-hedge-funds suggests that sophisticated investors are moving into these vehicles in search of alpha. We argue that this apparent mismatch between the supply of and demand for alpha has interesting implications for the organization of the hedge fund industry.
University of Oxford