Hedge Funds: A Dynamic Industry in Transition
Read the paperopens www.nber.org in a new tab
What they found
A wide-ranging survey of the hedge fund literature and industry. The authors cover the data problems (survivorship, backfill, self-reporting), the evidence on performance and persistence, the risk exposures of major strategies, the illiquidity and return-smoothing that inflate reported Sharpe ratios, the growth and institutionalization of the industry, and the systemic risk implications. They also document how the industry's aggregate alpha has declined as assets grew and as strategies became crowded, and describe the 2007 'quant meltdown' as an example of crowded-trade risk.
What you can use
- Hedge fund track records look better than they are because of database biases and return smoothing; discount reported Sharpe ratios accordingly.
- Industry-wide alpha has declined as assets have grown, the same capacity dynamic that governs every strategy.
- Crowded quant strategies can unwind violently and simultaneously, as in August 2007, even when each fund's risk looks fine on its own.
Caveats
A survey; conclusions reflect the literature through 2014. Free NBER version linked.
Tags: professional, hedge-funds, survey, crowding
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.