Do Hedge Fund Managers Display Skill?

Abstract

This study uses monthly data on 115 hedge funds for the seven-year period 1994–2000 to examine performance after accounting for target market indices and illiquidity effects. We find that the excess return on hedge funds is so small relative to the survivorship bias that it can be considered trivial, a finding suggesting no manager skill. Results also indicate that higher moments of returns do not appear to have a significant impact on the performance measure with excess returns. Incentive fees have significant positive effects on excess returns using the simple CAPM, but not on excess returns adjusted for illiquidity effects using the Dimson model. In addition, incentive fees appear to motivate hedge fund managers to reduce the systematic risk. Management fees, fund size, fund age, and leverage are important factors in explaining excess returns, but not in determining contemporaneous or lagged market betas.