Hedge Funds: Performance, Risk and Capital Formation
| Nov 3rd, 2006 | Filed under: Academic Research, Alternative Beta & Hedge Fund Replication | By: Alpha Male |
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By: Wiliam Fung, London Business School; David Hsieh, Duke University; Narayan Y. Naik, London Business School; Tarun Ramadorai, University of Oxford
Published: July 16, 2006
This paper analyses funds of hedge funds and has been widely circulated due to its conclusion that hedge fund alpha is shrinking. But it also contains a number of other important observations.
For example, high alpha producing funds of funds attract new capital in a consistent manner – regardless of recent past performance:
“…funds that produce alpha receive far greater inflows of capital than funds that only exhibit factor exposures. The capital flows into the alpha producing funds are steady, and do not significantly respond to recent past returns, while the flows into the remaining funds are characterized by return-chasing behavior.”
The paper also argues that excessive capital inflows lead to lower returns. This “capacity effect” has been percolating around the industry for several years. (But other research has shown that too many assets do not necessarily reduce returns.)
Finally, the paper suggests that managers who produce only (exotic) beta will be forced to lower their fees:
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