Original Article
Journal of Derivatives & Hedge Funds (2009) 15, 51–69. doi:10.1057/jdhf.2008.28
The performance persistence of equity long/short hedge funds
Practical Application Investors often allocate capital to specific hedge funds on the basis of the funds' track records, which implies that they expect some persistence in the funds' performance. In this context, large-scale studies analysing the performance persistence of hedge funds provide important insights on the expected success probability of such investment behaviour. From a practical point of view, the methodological approach chosen in this paper, which consists of repeatedly forming a portfolio based on observable information and then tracking it for the next period, represents a trading strategy that is conceptually easily implementable. However, lockup and redemption periods impede the implementation of such trading strategies. Consequently, an annual frequency of reforming the portfolios makes the strategies more feasible with respect to transaction costs and lockup periods, especially for funds of funds which often face more favourable conditions than individual investors.
Samuel Manser1 and Markus M Schmid2
Correspondence: Markus M. Schmid, Swiss Institute of Banking and Finance, University of St Gallen, Rosenbergstrasse 52, CH-9000 St Gallen, Switzerland
1is a portfolio engineer for Credit Suisse Asset Management, where he is responsible for the development of quantitative models for portfolio optimisation. He holds a BA in economics from the University of St Gallen and is currently pursuing an MA in quantitative economics from the University of St Gallen and a CFA degree.
2is an assistant professor of finance at the University of St Gallen, Switzerland. Before his current appointment, he was a post-doctoral research scholar at Leonard N. Stern School of Business, New York University. He holds an MA in economics and a PhD in finance, both from the University of Basel. His research interests are in the fields of empirical corporate finance, corporate governance and alternative investments.
Abstract
This paper examines the persistence of raw and risk-adjusted returns for equity long/short hedge funds using the portfolio approach of Hendricks et al Only limited evidence of persistence is found for raw returns. Funds with the highest raw returns last year continue to outperform over the subsequent year, although not significantly, while there is no persistence in returns beyond 1 year. In contrast, we find performance persistence based on risk-adjusted return measures such as the Sharpe Ratio and in particular an alpha from a multifactor model. Funds with the highest risk-adjusted performance continue to significantly outperform in the following year. The persistence does not last longer than 1 year except for the worst performers. Funds with significant risk-adjusted returns show less exposure to the market and have high raw returns and low volatility. These results are robust to adjustments for stale prices and sub-period analysis.
Keywords:
performance persistence, hedge funds, equity long/short, multifactor models
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