Hedge Fund Investors More Rational Than Rash

DALLAS, Sept. 4 /PRNewswire/ — Hedge fund investors’ tendency to focus on long-term performance strengthens hedge fund stability, according to the August issue of the Federal Reserve Bank of Dallas’ Economic Letter. In “Hedge Fund Investors More Rational Than Rash,” Assistant Vice President Jeffery W. Gunther and Harvard University student Anna Zhang examine a decade’s worth of data on hedge fund performance and money flows.

“Longer-term performance matters for hedge fund money flows, apparently more than short-run gyrations in returns,” the authors write. Investors tend to provide additional capital to hedge funds that outperform competitors, according to the authors.

“The positive association between managers’ skill and money flows enhances the stability of hedge fund liquidity because an individual fund’s profitability tends to elicit larger money flows in a down market than in an up one,”

Gunther and Zhang write.
As evidenced by hedge funds entangled in recent mortgage losses, adverse fund performance or even strong signals pointing in that direction can lead to abrupt capital outflows, the authors warn.
The August Economic Letter can be found at http://dallasfed.org/research/eclett/2007/el0708.html
Source: Federal Reserve Bank of Dallas.

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