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Hedge fund performance has weakened markedly since the financial crisis. No prediction model to select hedge funds could have overcome this trend, and the drivers of underperformance are still in place today.


Overview

This article documents a decline in aggregate hedge fund performance over the past decade. We tested whether a set of prediction models can select subsets of individual funds that buck the trend and subsequently outperform. Two of the predictors reliably picked funds that lowered the volatility and raised the Sharpe ratio of a multi-asset-class portfolio relative to a stock/bond portfolio over the full 1997–2016 sample. Hedge fund allocations reduced volatility in two subperiods but failed to improve the Sharpe ratio from 2008 onward. We explore potential explanations for the erosion of hedge fund performance.

About the Authors

Nicolas P.B. Bollen

Nicolas P.B. Bollen is the Frank K. Houston Professor of Finance at Vanderbilt University, Nashville, Tennessee.

Juha Joenväärä

Juha Joenväärä is an assistant professor of finance at Aalto University, Helsinki, Finland.

Mikko Kauppila

Mikko Kauppila is a doctoral candidate at the University of Oulu, Oulu, Finland.