Manager Characteristics and Hedge Fund Returns, Liquidity, and Survival

Abstract

Existing empirical studies assert that there is significant cross-sectional variation in the risk-adjusted returns of hedge funds, and that their performance is affected by manager characteristics such as education. However, when analyzing the impact of manager characteristics, prior research does not control for the difference in liquidity. In this study we find that manager education affects the liquidity of hedge fund shares and assets; on average, managers educated in elite institutions impose stronger share restrictions and thus can better manage illiquid assets to generate a liquidity premium. We also find that manager education affects the survival of hedge funds, but that the CFA designation has a stronger impact. From 1994 to 2015, the hazard rate of CFA funds was 13.6% lower, and the difference was significant after controlling for risk, return, and investment style effects. Our findings are important because the search and due diligence process is costly for investors such as pension funds—and survival rates reduce costs.

TOPICS: Performance measurement, manager selection, style investing

Key Findings

• • Manager characteristics such as education affect the liquidity of hedge fund shares and assets. On average, hedge funds whose managers were educated in elite institutions imposed stronger share restrictions and invested in more illiquid assets than other funds did.

• • Share restrictions enable funds to better manage illiquid assets, and the skills and alumni networks of managers contribute to this advantage. This article shows that the major driving force is trust inspired by the reputation and network of elite institutions.

• • The educational backgrounds and certification of hedge fund managers are related not only to the liquidity premium that long-horizon investors can earn, but also to the lower search costs due to the higher survival rates.