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Decreasing returns to scale and skill in hedge funds

Author

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  • Ling, Yun
  • Satchell, Stephen
  • Yao, Juan

Abstract

In this paper, we investigate value creation by hedge funds using Berk and van Binsbergen's (2015) value-added. We find that, on average, hedge fund managers extract $0.76 million dollars per month from the market. We provide strong evidence of persistence in value creation by hedge fund managers. Of three skill indicators—skill ratio, fee ratio, and total compensation—we find that total compensation best identifies the skilled manager out-of-sample. Investors in value-creating funds benefit from a more favourable risk–return payoff. While hedge funds typically operate in a less competitive market than mutual funds, our findings suggest that incentive fees do not indicate greater skill. The value that hedge funds can extract from the market depends on both the profitability and scalability of their investment strategies.

Suggested Citation

  • Ling, Yun & Satchell, Stephen & Yao, Juan, 2023. "Decreasing returns to scale and skill in hedge funds," Journal of Banking & Finance, Elsevier, vol. 156(C).
    • Handle: RePEc:eee:jbfina:v:156:y:2023:i:c:s0378426623002005
    DOI: 10.1016/j.jbankfin.2023.107009
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    More about this item

    Keywords

    Hedge funds; Managerial skill; Fee structure; Diseconomies of scale; Value added;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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