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Funds of Hedge Funds (FoHFs) continue to gain acceptance among institutional investors and high-networth individuals who are looking for exposure to alternative assets. According to International Financial Services London (April 2010 report), FoHF assets totaled around $500 billion, or some 30% of global hedge fund assets. Despite the negative publicity toward FoHFs in the post-crisis months, they seem to be recovering, with improving returns and fresh inflows lately.
Competition among financing providers for funds of hedge funds (FoHFs) is heating up as FoHF demand grows. Specifically, according to the HFMWeek 16th Biannual Assets under Administration (AuA) Survey,1 FoHF assets rose by some $40 billion from October 2010 to April 2011, to reach $1.1 trillion, a growth of 4%.
The success of FoHFs was originally driven by smaller investors who did not have the possibility and the capital to invest directly in hedge funds. Despite the size of the market for FoHFs, little is known about the performance of FoHF managers (Eling [2009]; Ammann and Moerth [2008]; Fung, Hsieh, Naik, and Ramadorai [2008]). Furthermore, numerous studies have focused on the performance persistence of mutual funds. However, as alternative investments, FoHFs provide absolute returns that do not follow traditional benchmarks. It is therefore more suitable to analyze the performance persistence of FoHF managers than mutual fund managers, especially when we consider the illiquid nature of their investments, namely the long lock-up periods on capital and infrequent redemption notice periods that these funds often impose on investors.
Further, as highlighted by Brown, Goetzmann, and Liang [2004], the double layer fees that FoHFs impose could induce FoHF managers to invest in excessively risky hedge funds and could absorb all the annual fund return. Finally, FoHFs generally provide institutional investors with a diversified hedge fund portfolio. FoHF returns thus suffer less from the biases that characterize individual hedge fund returns, such as survivorship bias, instant bias, and self-selection bias (Ammann and Moerth [2008], and Fung and Hsieh [2002]). These features advocate treating FoHF separately from the hedge funds category.
The objective of this study is to examine the performance persistence of FoHFs using non-parametric approaches. This article contributes to our understanding of persistence among alternative investments in different ways. First, we consider a new database of FoHFs that covers...