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Passive Hedge Funds

Passive Hedge Funds

H/T Matt Levine

Mikhail Tupitsyn

Monash Business School

Paul Lajbcygier

Monash University - Department of Banking & Finance

August 10, 2015

Abstract:

We show that most hedge fund managers are passive, not active. Active management should be manifest through nonlinear exposure to the systematic risk factors that drive hedge fund returns. In order to demonstrate managerial skill enhanced performance should accrue as a consequence of active management. Using generalized additive models we find that approximately two-thirds of Hedge Funds exhibit only linear factor exposures and hence are “passive”. What’s more such “passive” managers tend to outperform “active” managers. Finally, we also show that many “active” managers, despite initial nonlinear risk exposures, eventually become “passive”.

Passive Hedge Funds - Introduction

The question at the heart of this study is simple: do most hedge fund managers generate returns through managerial skill? The answer, according to our work is no. Most hedge fund managers rely on “passive” linear risk exposures to generate their returns and, paradoxically, they outperform most “active” managers which try to deploy skill.

To demonstrate skill, a hedge fund manager must generate enhanced performance through active management. Such skill should be manifest through nonlinear exposure to the systematic risk factors that drive hedge fund returns and as a...


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