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Alternative Market Briefing

Study says funds of hedge funds have significant fund selection abilities

Friday, August 04, 2017

Matthias Knab, Opalesque:

Given a number of recent unfavorable trends, investors wonder whether funds of hedge funds (FOHFs) offer any value added as investment vehicles. This study by Chao Gao, Tim Haight, and Chengdong Yin seeks to shed light on this question by examining managers' abilities in the FOHF industry using holding-level data. We focus on two key abilities: fund selection and style allocation. Fund selection concerns picking funds with superior performance, either in general or within a style. Style allocation concerns managers' abilities to time the performance of different investment styles and allocate capital accordingly.

Overall, the authors find that FOHFs have significant fund selection abilities. Individual hedge funds held by FOHFs outperform not only their style indices but also the majority funds in the TASS database. In addition, FOHFs' holdings with positive flows outperform those with negative flows. Thus, FOHFs are smart in that they add value when they adjust their holdings over time. Nevertheless, FOHFs do not exhibit consistently strong style allocation abilities, which may reflect lower importance placed on style allocation abilities (relative to fund selection abilities) in the hedge fund industry.

The authors say their study has several important implications for FOHF investors. For example, in terms of choosing among different FOHFs, our analysis suggest that FOHFs with larger size and multiple general styles are more likely to h......................

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