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

Flows and Performance

The long and short equity strategy saw steady growth in assets under management from the beginning of the millennium until 2008. Institutional investors are attracted to the strategy due to its familiarity and similarity to traditional equity investing and its ability to positively impact portfolio returns when used as a substitute for traditional equity allocations.

According to data compiled by HFR, the strategy had only $25 billion in 2002, before almost doubling to $40 billion by 2004. This influx in assets was too much for the capacity of the strategy to handle and resulted in a collapse in returns, followed by an increase in redemptions. In 2005, prior to the financial crisis, the strategy had net outflows and retraced its growth back to $25 billion in assets before expanding again in 2006 and 2007 to a new high. The strategy was adversely affected by the financial crisis more than most hedge fund strategies and suffered losses, redemptions, a lack of liquidity, and a contracting primary market for new issues. The strategy recovered quickly after the crisis and is now at an all-time high in assets under management, although capacity remains tight. At the end of 2011, the strategy had grown to above $41 billion and in 2012 exceeded its earlier peak of $42 billion.

Investors have generally been rewarded with positive quarterly performances over changes in the business cycle. The strategy lost money in the third quarter of 2008 but rebounded in the fourth ...