¹Feri Institutional Advisors GmbH, Haus am Park, Rathausplatz 8–10, Bad Homburg 61348, Germany. Tel: +49 (6172) 916 3712; Fax: +49 (6172) 916 1700; E-mail: dieter.kaiser@feri.de

²Dr Dieter Kaiser is Director Hedge Funds at Feri Institutional Advisors GmbH in Bad Homburg, Germany where he is responsible for managing hedge funds portfolios. From 2003 to 2007 he was responsible for institutional research at Benchmark Alternative Strategies GmbH in Frankfurt, Germany. He has written numerous articles on hedge funds that have been published in both, academic and professional journals and is the author and editor of seven books. Dieter Kaiser holds a BA in Business Administration from the University of Applied Sciences Offenburg, an MA in Banking and Finance from the Frankfurt School of Finance and Management, and a PhD in Finance from the Chemnitz University of Technology. On the academic side, he is a research fellow at the Centre for Practical Quantitative Finance of the Frankfurt School of Finance and Management.

Received 28 January 2008; Revised 28 January 2008.

Abstract

Hedge fund managers proclaim that they predominantly use investment strategies that generate profit from misvalued market instruments. Regarding efficient market theories, hedge funds use market price anomalies and hence serve to increase market efficiency. Especially with arbitrage-based strategies, however, in highly competitive markets it is possible that excess returns will vanish over time because other investment managers will 'jump on the bandwagon', and trade similar inefficiencies, thus diminishing risk premiums. Hedge fund excess returns will naturally decrease over time. The thesis that hedge funds develop according to this pattern is called the 'lifecycle theory of hedge funds'. This paper empirically investigates the lifecycle theory based on an extensive database of 1,433 hedge funds for the period January 1996 until May 2006. We verify that hedge funds indeed follow a lifecycle.