Superstars or Average Joes? A Replication-Based Performance Evaluation Of 1917 Individual Hedge Funds
Nov 30th, 2006 | Filed under: Alternative Beta & Hedge Fund ReplicationBy: Harry Kat & Helder Palaro, Cass Business School, City University London
Published: February 3, 2006
This paper is the third and final installment of our “Harry Kat Trilogy” this week. In it, Kat & Palaro apply their methodology to individual hedge funds (as opposed to funds of funds as they did in earlier research).
It is quite apparent from their conclusions why they subsequently embarked on a quest to replicate hedge funds:
“…we find that no more than 17.7% of the hedge funds in our sample beat the benchmark. In other words, the majority of hedge funds have not provided their investors with returns, which they could not have generated themselves by mechanically trading S&P 500, T-bond and Eurodollar futures. Over time, we observe a substantial deterioration in overall hedge fund performance. In addition, we find a tendency for the performance of successful funds to deteriorate over time, which supports the hypothesis that increasing assets under management endanger future performance.”
The paper covers a lot of ground from “Who Needs Hedge Funds?”, the duo’s earlier treatise, and then launches into the results of applying the “KP” methodology to nearly 2,000 individual hedge funds.
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[…] “Based on our own research, we estimate that in the current environment in 70-80% of the cases a hedge fund (of funds) manager’s contribution to the after-fee bottom line is zero or negative. Whenever this is the case, investors basically allow the manager to make a (very good) living using their money, without getting anything in return. Unless one is genuinely attracted to this form of charity, in these cases it is worth replacing the manager in question by a synthetic fund. A synthetic fund produces no pre-fee alpha, but it doesn’t cost a fortune to run either. In addition to generating hedge fund resembling returns, synthetic funds also come with a number of other benefits, such as great improvements in liquidity, transparency, capacity, etc., which makes the decision to go for the synthetic fund even easier. […]