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Produced in collaboration with New York University (NYU), the study finds hedge fund "Best Ideas" have not outperformed the rest of their portfolios, despite the identification of statistically significant outperformance (alpha) by those portfolios against the broader marketplace for a period of 20 years.

Epsilon partners Faryan Amir-Ghassemi and Michael Perlow co-authored the report with National Science Foundation award-winning assistant professor of finance and risk engineering Andrew Papanicolaou of NYU.

The study examined the publicly reported portfolio positions of nearly 1,500 hedge funds from 1999 to 2018 to quantify the stock picking skill of these vaunted managers, and to see whether their Best Ideas truly outperformed the market and deserve the attention they generally receive in the media and at industry events.

Key Findings:

New scientific and academic evidence of true stock picking skill across the spectrum of hedge fund managers.

No systematic outperformance of Best Ideas versus other portfolio positions held by hedge fund managers, across all size funds, and over all time periods.

A strong inference that the incentive fee portion of a hedge fund manager's compensation dissuades the manager from seeking wealth solely through asset accumulation.

The evidence developed by the report broadly suggests that hedge fund Best Ideas do not outperform the rest of their portfolio positions, contrary to both popular belief and comparable studies on mutual funds.

"The message here for investors is that if you are pitched a 'Best Idea' by a hedge fund, you need to see the evidence and substantiation of outperformance for yourself," said Amir-Ghassemi. "With industry conferences and dinners devoted to identifying the supposed best bets of active management, our study is a clarion call about the importance of understanding hedge fund portfolio construction and how a fund is assessing risk and sizing investment decisions."

"With a rigorous look across a broad spectrum of the industry for two decades, and employing a variety of quantitative methodologies, the evidence was clear," said Papanicolaou. "While hedge funds can rightly boast of stock picking skill, the notion that 'Best Ideas' show any statistical outperformance against the rest of their portfolios was simply not supported by our findings."

By looking at two distinct periods of recent history, 1999-2009 and 2009-2018, the study uncovered two further warnings for investors:

The size and growth of the hedge fund industry has had a deleterious effect on alpha generation.

The presence of a bull or bear market has important implications for hedge funds' ability to generate alpha.

Additional findings:

In the past 20 years, hedge funds have generated 250 basis points (2.5%) of annualized alpha across their long domestic stock picks.

Generally speaking, smaller firms generated more alpha over the period than larger firms.

Alpha was demonstrably greater from 1999 to 2009 than from 2009 to 2018.

Over time, alpha has decayed in tandem with the rise of hedge fund assets.

Active management still produces real value, specifically when overseen by incentive-fee managers.