Investing in Hedge Funds when Returns are Predictable

• Main Authors: AVRAMOV, Doron, KOSOWSKI, Robert, NAIK, Narayan Y., TEO, Melvyn
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2007
• Subjects: Hedge Funds; Predictability; Managerial Skills; Asset Allocation; Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/bnp_research/6; https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=1004&context=bnp_research
• Institution: Singapore Management University

This paper evaluates hedge fund performance through portfolio strategies that incorporate predictability in managerial skills, fund risk loadings, and benchmark returns. Incorporating predictability substantially improves performance for the entire universe of hedge funds as well as for various investment styles. The outperformance is strongest during market downturns when the marginal utility of consumption is relatively high. Moreover, the major source of investment profitability is predictability in managerial skills. In particular, long-only strategies that incorporate predictability in managerial skills outperform their Fung and Hsieh (2004) benchmarks by over 17 percent per year. The economic value of predictability obtains for different rebalancing horizons and alternative benchmark models. It is also robust to adjustments for backfill bias, incubation bias, illiquidity-induced serial correlation, fund fees, and style composition.