The Performance Life Cycle of Hedge Funds: Can Investors Achieve Lasting Performance?

Abstract

This article examines the performance life cycle of hedge funds. Performance declines with age are pervasive, not just for the average hedge fund, but also for past winners and funds with characteristics that predict cross-sectional fund returns. The authors examine several possible mechanisms and find that fund growth and decreasing fund manager performance incentives contribute to performance declines with age. Performance declines in early years coincide with a sharp drop in strategy distinctiveness, which suggests that declines are related to an inability to maintain strategy secrecy. Horse racing analysis suggests that investors can exploit life cycle mechanisms, as portfolios of funds that are small and have strong performance incentives (regardless of age) deliver superior performance with greater consistency than even past winners do.