Hedge Fund Flows Flashcards
Why do hedge fund investors rely heavily on CAPM when evaluating funds?
CAPM alpha explains hedge fund flows better than more sophisticated models, suggesting investors prioritize simplicity over model complexity.
What are the three return components that hedge fund investors consider when allocating capital?
- Alpha (manager skill), 2. Traditional risk premia (size, value, market beta), 3. Exotic risk premia (momentum, options, derivatives strategies).
Why do investors emphasize exotic risk exposures more than traditional ones?
Hedge funds offer unique risk exposures not available in traditional investment vehicles, reinforcing the notion that ‘exotic beta is hedge fund alpha’.
Why do investors continue to chase past hedge fund returns despite little persistence in performance?
Investors overestimate their ability to pick winning funds based on past success, even though past returns from traditional and exotic risks do not reliably predict future performance.
How do hedge fund fees influence investors’ sensitivity to risk exposures?
Investors paying higher performance fees are more sensitive to exotic risk returns, expecting hedge funds to provide access to unique strategies.
How do funds of hedge funds (FoFs) behave compared to institutional investors?
FoFs allocate more capital toward exotic risk exposures, similar to institutional investors, but do not use more sophisticated performance models.
How did hedge fund investors’ risk preferences evolve over time?
Before 2005, investors did not differentiate between traditional and exotic risks. After 2005, with the rise of advanced risk models, they began distinguishing between them.
Why is CAPM alpha still dominant in hedge fund performance evaluation?
Despite more sophisticated models, CAPM remains widely used because of its simplicity and investors’ preference for easy-to-understand performance metrics.
What is the key implication of the study for investors choosing hedge funds?
Investors should focus on understanding risk exposures rather than blindly chasing past returns, as past performance is not a reliable indicator of future success.
How could investors improve their hedge fund selection strategies?
By using more sophisticated risk models that differentiate between types of risks, ensuring better capital allocation between hedge funds and other investment vehicles.
Why does CAPM alpha explain hedge fund flows better than multifactor models?
Hedge fund investors treat traditional and exotic risk exposures as part of alpha, failing to fully differentiate between risk sources.
What does the study suggest about hedge fund investors’ ability to identify manager skill?
Investors often conflate true alpha with risk-based returns, leading to suboptimal capital allocation decisions.
What role do hedge fund incentives play in investors’ preference for exotic risk exposures?
Hedge fund managers are incentivized to take on exotic risks because investors associate these with skill, leading to higher inflows.
How do institutional investors differ from retail investors in their hedge fund allocation?
Institutional investors allocate more capital toward exotic risk exposures and tend to have longer investment horizons.
What does the study imply about hedge fund investors’ use of risk models?
Despite advances in asset pricing, hedge fund investors still rely on basic models, overlooking the benefits of more accurate multifactor frameworks.
Why do hedge fund investors still chase past returns despite clear evidence against return persistence?
Behavioral biases and historical reliance on past performance lead to repeated misallocation of capital.
What does the study suggest about the future of hedge fund performance evaluation?
Future hedge fund evaluation should integrate better risk differentiation and robustness checks to improve capital allocation decisions.
