Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Academic Research in Support of Hedge Fund Investing

Investing in hedge funds is an extension of the use of specialized knowledge to obtain maximum return-risk trade-offs. It represents an evolution in traditional investing rather than a revolution. Investors who add specialized managers such as hedge funds can obtain returns in market conditions and types of securities not generally available to traditional asset managers. This is particularly true, given the number of hedge fund investment strategies that offer risk and return opportunities that are not usually associated with traditional stock and bond investments.

The growth in assets from just over $300 billion in the late 1990s to $2.4 trillion by 2007 corresponded to a period of extensive research on hedge funds as an asset class, as well as the relationship of individual styles to market factors and other non–market related performance drivers.

The initial academic research on hedge fund performance mostly evaluated the positive portfolio effects of adding hedge funds to institutional portfolios as well as the basic differences in liquidity, risk, factor exposures, and return characteristics between the dynamic trading styles used by hedge funds and traditional buy and hold strategies (Ackerman and McEnally 1999; Fung and Hsieh 1997).

The Agarawal and Naik (1999) study on the impact of market factors on fund performance used six specific directional fund strategies and six non–directional arbitrage strategies. They evaluated ...