DP12599 The Effect of Investment Constraints on Hedge Fund Investor Returns

Author(s): Juha Joenväärä, Robert Kosowski, Pekka Tolonen
Publication Date: January 2018
Keyword(s): frictions, Hedge Fund Performance, Managerial Skill, Persistence
JEL(s): G11, G12, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12599

This paper examines the effect of investor-level real-world investment constraints, including several which had not been studied before, on hedge fund performance and its persistence. Using a large consolidated database, we demonstrate that hedge fund performance persistence is significantly reduced when rebalancing rules reflect fund size restrictions and liquidity constraints, but remains statistically significant at higher rebalancing frequencies. Hypothetical investor portfolios that incorporate additional minimum diversification constraints, minimum investment requirements, and focus on open funds suggest that the performance and its persistence documented in earlier studies of hedge funds is not easily exploitable, especially by large investors.