The Performance of Hedge Funds: Risk, Return, and Incentives

Authors

  • Carl Ackermann,

    1. College of Business Administration, University of Notre Dame
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  • Richard McEnally,

    1. Kenan-Flagler Business School, University of North Carolina, Chapel Hill
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  • David Ravenscraft

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    • * Ackermann is at the College of Business Administration, University of Notre Dame. McEnally and Ravenscraft are at the Kenan-Flagler Business School, University of North Carolina, Chapel Hill. We thank Brian Barrett, Ken French, Martin Gross, Lee Hennessee, Lois Peltz, Indira Peters, Jacob Punnoose, Dick Oberuc, Richard Rendleman, Steve Slezak, René Stulz, three anonymous referees, and seminar participants at the 1997 American Finance Association Meetings, the 1996 European Hedge Fund Conference, the 1996 Financial Management Association Meetings, and the University of North Carolina at Chapel Hill for helpful comments and suggestions. We also gratefully acknowledge UNC's Center for Financial Accounting Research for data funding and a Pipkin Faculty Development Award and Townsend Research Fellowship for summer support.

Abstract

Hedge funds display several interesting characteristics that may influence performance, including: flexible investment strategies, strong managerial incentives, substantial managerial investment, sophisticated investors, and limited government oversight. Using a large sample of hedge fund data from 1988–1995, we find that hedge funds consistently outperform mutual funds, but not standard market indices. Hedge funds, however, are more volatile than both mutual funds and market indices. Incentive fees explain some of the higher performance, but not the increased total risk. The impact of six data-conditioning biases is explored. We find evidence that positive and negative survival-related biases offset each other.

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