The Anatomy of an Outperforming Hedge Fund

Newly formed hedge funds outperformed established managers in up- and down-markets, while long-only funds without lock-up restrictions suffered significantly during recessions.

Which hedge funds are most likely to deliver excess returns?

In a recent report, Dimitrios Stafylas of Aston University Business School broke down hedge fund performance by fund characteristics including size and strategy, as well as business cycles and market conditions.

For the study, he used data from EurekaHedge and BarclayHedge from January 1990 to March 2014, covering three US business cycles.

This approach showed hedge funds only delivered excess returns during “good” times and attempted to minimize their systematic risk during “bad” times.

Small funds, new funds, and funds with redemption restrictions delivered the highest alpha with respect to peers during the “good times.” However, while young funds continued to outperform old funds during the “bad times,” small funds suffered more than their large counterparts. Lockup funds also underperformed those that did not impose restrictions (assuming they survived withdrawals).

The worst performing hedge funds during stressful market conditions were long-only funds without redemption restrictions and newly created multi-stately funds. The hedge funds best able to provide “extraordinary excess returns” during these “bad” times were small and established hedge funds relying on niche strategies and tools not commonly used by other funds, such as private investment in public equity and allocations to start-ups.

“There is an association between specific fund characteristics (fundamental factors) and fund performance,” Stafylas wrote. “These studies are important for understanding hedge fund behavior.”

Read the full report, “Hedge Fund Performance Attribution at Fundamental and Mixed Level under Different Market Conditions.” 

Related: Insurers Up Risk, Alts Amid Interest Rate Uncertainty; Don’t Count on Hitting Your Return Target: ResearchAffiliates