Multi-period performance persistence analysis of hedge funds

Finance

IFA Working Paper

Agarwal V; Naik N Y

Narayan Naik

2000

Since hedge funds specify significant lockup periods, we investigate persistence in the performance of hedge funds using a multi-period framework in which the likelihood of observing persistence by chance is lower than that in the traditional two-period framework. Under the null hypothesis of no manager skill (no persistence), the theoretical distribution of observing wins or losses follows a binomial distribution. We test this hypothesis using the traditional two-period framework and compare the finds with the results obtained using our multi-period framework. We also examine whether persistence is sensitive to the length of return measurement intervals by using quarterly, half-yearly and yearly returns. We find that the level of persistence observed in our multi-period framework is considerably smaller than that observed in the two-period framework. We note that the extent of persistence decreases as we move from quarterly to yearly returns irrespective of the type of framework used, with virtually no evidence of persistence using yearly returns under the multi-period framework. Though persistence seems to be largely driven by losers, we find that there are a few good managers who consistently perform well for long periods of time indicating the importance of manager selection in case of hedge funds. Finally, the persistence, whenever present, seems to be unrelated to whether the fund took directional bets or not.

Institute of Finance and Accounting

FIN 298

IFA Working Paper

No