Recent Advances In Hedge Funds’ Performance Attribution

Recent Advances in Hedge Funds’ Performance Attribution: Performance Persistence And Fundamental Factors

Dimitrios Stafylas

University of York – The York Management School

Keith P. Anderson

The York Management School

Muhammad Moshfique Uddin

University of Leeds – Division of Management

October 29, 2015

International Review of Financial Analysis, Forthcoming


We survey articles on hedge funds’ performance persistence and fundamental factors from the mid-1990s to the present. For performance persistence, we present some pioneering studies that contradict previous findings that hedge funds’ performance is a short term matter. We discuss recent innovative studies that examine the size, age, performance fees and other factors to give a 360° view of hedge funds’ performance attribution. Small funds, younger funds and funds with high performance fees all outperform the opposite. Long lockup period funds tend to outperform short lockups and domiciled funds tend to outperform offshore funds. This is the first survey of recent innovative and challenging studies into hedge funds’ performance attribution, and it should be particularly useful to investors trying to choose between hedge funds.

Recent Advances In Hedge Funds’ Performance Attribution – Introduction

In the hedge fund literature there are many studies dealing with performance persistence3 along with other studies that investigate the relationship between fund returns and fund specific characteristics such size, age and fees4. Although these studies use different databases and time periods, they can nevertheless provide a useful guide to investors. Investors expect performance to be stable over time and that some fund managers outperform their peers. Also funds may show an association between their returns and characteristics such as size, age, fees or other fundamental factors. Until now, there has been no survey summarizing all the results and there is no uniform conclusion on these issues, thus creating confusion for investors. Consequently, the present study closes an important gap. The aim of this study is to survey the literature and investigate hedge fund performance in terms of (i) return persistence and (ii) the relation of fund returns to fund characteristics (fundamental factors) such as size, age, fees and other factors (e.g. lockup and domicile factors as explained in section five). This is the first survey and synthesis of older literature to provide a historical perspective, together with information from recent innovative studies to delineate advances in performance persistence and the attributes of individual hedge funds. Our findings both assist hedge fund investors and unravel opportunities for further research, as we describe later. Despite the difference in studies, there are some consistent trends and patterns that reveal useful aspects about hedge fund behaviour in terms of performance persistence and the relation between performance and fund characteristics.

Our main conclusions are that early studies (e.g. Agarwal and Naik, 2000a, Bares, Gibson and Gyger, 2003) showed that there is short term persistence (less than a year). Moreover, there is evidence that some non-directional strategies (e.g. e.g. Convertible Arbitrage or Merger Arbitrage strategies) present more persistence than directional strategies (e.g. Long Only or Short Bias strategies). The difference in persistence is mainly related to the type of strategy each fund follows. However, some later studies (e.g. Kosowski, Naik and Teo, 2007; Jagannathan, Malakhov and Novikov, 2010; Amman, Huber and Schmid, 2013) have challenged the above studies and showed that there is persistence beyond one year and possibly up to five years. Concerning the fundamental factors and fund returns, most studies show that there is a negative relationship between fund size and performance. Regarding the age factor there is a clear negative relationship between age and performance. There is also a positive relationship between incentive fees and fund performance. Funds imposing lockups outperform funds that do not impose lockups and on-shore funds outperform off-shore registered funds.

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Our paper makes a number of important contributions to the understanding of the literature. First of all, we close a gap by presenting a survey that summarizes all the results concerning hedge fund return persistence and the relation between fund characteristics and fund returns. In addition, we present a historical perspective by combining older and newer, innovative studies. Thus the reader is able to observe the dynamic nature of the literature in explaining fund return persistence and fund returns according to the underlying fundamental factors. Our study helps investors in their asset allocation process as it enables them, firstly, to assign the appropriate weight (according to their needs) in fund selection based on their past returns. Secondly, it enables them to know what to expect from funds with different characteristics. Moreover, we have identified some gaps for future research, such as the absence of a unified framework that examines the effect of fundamental attributes and their interactions on hedge fund performance. We detail these research opportunities in the Conclusion.

In section 2 we provide a necessarily brief overview of the hedge fund industry. Section 3 describes the different categories of models for hedge fund returns. Section 4 surveys the literature on hedge funds’ performance persistence and section 5 covers the literature that seeks to explain hedge fund returns using their characteristics. In these two parts we review all these issues and then discuss some logical observations about the underlying studies. In the final section 6 we present and summarize the key conclusions and reveal some gaps that should be covered in future research.

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