Do Hot Hands Exist among Hedge Fund Managers? An Empirical Evaluation
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What they found
The authors tested whether hedge fund performance persists over three-year horizons, correcting for the biases (backfill, survivorship, and the tendency of poorly performing funds to stop reporting) that plague hedge fund databases. They found statistically and economically significant persistence among funds that outperformed: roughly half of a fund's abnormal performance in one three-year period carried into the next. Persistence was concentrated in the winners; poorly performing funds did not reliably continue to underperform, partly because they closed.
What you can use
- Unlike mutual funds, hedge funds with strong multi-year records did tend to keep outperforming, though only about half of the edge persisted.
- Skill persistence was visible at three-year horizons, not one-year; short records are too noisy to distinguish skill.
- Database biases (funds stopping reporting when they do badly) can manufacture fake persistence; correcting for them is essential.
Caveats
Hedge fund databases are self-reported and the corrections are model-based. Sample 1996 to 2005. Persistence in returns to investors is smaller after fees and flows.
Tags: professional, hedge-funds, persistence, skill
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.