“Return persistence” can now be viewed with the naked eye
Aug 4th, 2008 | Filed under: Performance, Analytics & Metrics“Performance persistence” is never far from the minds of both hedge fund investors and researchers. Many studies have attempted to determine if good managers can actually remain good or if their performance is destined to “revert to the mean”. In general, they conclude that persistence does exist…bad managers remain bad. Unfortunately, the opposite is not generally believed to be very true.
One author of a recent study on return persistence, Daniel Capocci, found that previous returns showed modest predictive ability and wrote on these pages last March:
“…we found that the alphas were significantly positive for deciles 2 to 8 in the previous year’s performance rankings, but not for the previous year’s best and worst performing funds.”
Now Markus Schmid and Samuel Manser of the Swiss Institute of Banking and Finance and Credit Suisse say they have identified what they say is a better way to measure persistence – by looking at only one strategy, long/short equity. Taking aim at Capocci and others, they argue that lopping hedge funds with different investment strategies into the same analysis is less robust. Analysing just one strategy, on the other hand, removes strategy-specific betas from the equation.
Like Capocci, they divide hedge funds into 10 portfolios depending on their previous performance. Then they track the performance of those portfolios going forward. Here’s what they found: More…
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Curious as to how the authors calculated alpha for the L/S managers. Was it possible to correct for varying levels of market exposure, thereby tracking a “purer” alpha. Were factor betas (size, style, etc.) accounted for? Was the return data “scrubbed” in any other way to arrive at the alphas?