Identifying Performance Persistence in Hedge Funds Using a Measure of Manager Skill

Abstract

In this article, the authors discuss the challenges in identifying performance persistence among hedge funds and introduce a novel measure of manager skill, termed MMS, to address them. Funds with higher MMS scores deliver larger returns with lower volatilities, better tail-risk behavior, and less liquidation risk in subsequent periods than funds with lower MMS scores. The results cannot be explained by differences in fund characteristics or market exposures and are robust to the choice of rebalancing frequency and the existence of backfill bias.

TOPICS: Manager selection, performance measurement

Key Findings

• • The authors introduce a novel measure of skill and demonstrate it is capable of differentiating among hedge funds based on their past performances.

• • Funds with better skill generate subsequently both higher returns and improved risk properties.

• • The results cannot be explained by differences in fund characteristics or market exposures and are robust to the choice of rebalancing frequency and the existence of backfill bias.