Benoit Dewaele, Hugues Pirotte, Nils Tuchschmid and Erik Wallerstein
Abstract
This paper studies the performance of a sample of funds of hedge funds (FoHFs) from January 1994 to August 2009. We apply the false discoveries (FD) technique of Barras, Scaillet and Wermers (2010) to separate the FoHFs into skilled, zero-alpha and unskilled. We measure the alpha of the FoHFs using two models – (1) a 16-factor model with a combination of factors from Fung and Hsieh (2004) and Capocci, Corhay and Hübner (2005) and (2) a 13-factor model of hedge fund indices from Dow Jones Credit Suisse. Applying the FD procedure to the first model, we find that, after fees, the majority of FoHFs do not channel alpha from single-manager hedge funds. Applying the FD procedure to the second model, we find that only a very small fraction of FoHFs deliver after-fees alpha per se, i.e. on top of the alpha of the hedge fund indices. A series of robustness checks confirms the results of the FD procedure. We also compare the performance of our sample of FoHFs to artificial FoHFs constructed by randomly picking hedge funds. The lack of significant differences in the average performance of the real and artificial FoHFs confirms the results obtained by the FD procedure.
H/T to Barry Ritholtz over at The Big Picture for pointing me towards this paper which was referenced in the article: Can a monkey pick a hedge fund? over at MarketWatch where Brett Arends writes:
I believe in reason, logic and the human mind, so I wish I could say the first. Alas, I have just finished reading “Assessing the Performance of Funds of Hedge Funds,” a research paper produced by Benoit Dewaele and Hugues Pirotte of the Universite Libre de Bruxelles (the Brussels Free University in Belgium), and Nils Tuchschmid and Erik Wallerstein of the Geneva School of Business Administration in Switzerland. The paper is here.
They studied a broad sample of 1,300 funds-of-funds from 1994 through 2009, and analyzed just how much value they actually created.
Their core finding? When you strip out the fees, just 22% deliver any “alpha,” or risk-adjusted investment gains, at all.
