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Capacity Constraints and Hedge Fund Strategy Returns

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  • Narayan Y. Naik
  • Tarun Ramadorai
  • Maria Stromqvist

Abstract

Hedge funds have generated significant absolute returns (alpha) in the decade between 1995 and 2004. However, the level of alpha has declined substantially over this period. We investigate whether capacity constraints at the level of hedge fund strategies have been responsible for this decline. For four out of eight hedge fund strategies, capital inflows have statistically preceded negative movements in alpha, consistent with this hypothesis. We also find evidence that hedge fund fees have increased over the same period. Our results provide support for the Berk and Green (2004) rational model of active portfolio management.

Suggested Citation

  • Narayan Y. Naik & Tarun Ramadorai & Maria Stromqvist, 2007. "Capacity Constraints and Hedge Fund Strategy Returns," European Financial Management, European Financial Management Association, vol. 13(2), pages 239-256, March.
    • Handle: RePEc:bla:eufman:v:13:y:2007:i:2:p:239-256
    DOI: 10.1111/j.1468-036X.2006.00353.x
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