Blog - Investing Notes

April 12, 2005 – What It Takes to Drive the Big (Hedge Fund) Rigs...

Hedge funds now haul about $1 trillion in capital from opportunity to opportunity around world markets. Hedge fund managers have latitude to operate in ways that mutual fund managers do not in terms of leverage, shorting and types of assets traded (such as derivatives). What makes the best hedge fund managers successful? In their March 2005 paper entitled "Hedge Fund Performance and Manager Characteristics — Education and Age Matter...", Haitao Li, Rui Zhao and Xiaoyan Zhang correlate the background characteristics of hedge fund managers with the performances of their funds. Using a dataset encompassing 1,000+ hedge funds over the period 1994 to 2003, they conclude that:

• Some hedge fund managers do consistently outperform their peers.
• Hedge fund managers with undergraduate degrees from schools with high average student SAT scores tend to outperform at lower risk. All other things being equal, a 200-point higher average SAT score means 0.64% to 0.96% more risk-adjusted excess return per year.
• More experienced hedge fund managers tend to underperform. All other things being equal, 5 years more working experience means 0.29% to 0.69% less risk-adjusted excess return per year.
• In parallel with the effect of manager experience level, old hedge funds tend to underperform.

In summary, smart young (hedge fund) drivers wanted. These results might prompt individual investors to ask themselves the following questions:

1. Am I evaluating investments, including risk mitigation, analytically or dogmatically (without new tricks)?

2. Am I open to new ideas, and am I keeping up with new research on investing/trading?

3. Do I consider and integrate relevant information from many sources, and do I continually add new sources?