Hedge Fund Flows and Performance Streaks: How Investors Weigh Information

Guillermo Baquero; Marno Verbeek

doi:10.1287/mnsc.2021.4067

Hedge Fund Flows and Performance Streaks: How Investors Weigh Information

Guillermo Baquero, Marno Verbeek

Department of Finance

Research output: Contribution to journal › Article › Academic › peer-review

5 Citations (Scopus)

149 Downloads (Pure)

Abstract

Cash flows to hedge funds are highly sensitive to performance streaks, a streak being defined as subsequent quarters during which a fund performs above or below a benchmark, even after controlling for a wide range of common performance measures. At the same time, streaks have limited predictive power regarding future fund performance. This suggests investors weigh information suboptimally, and their decisions are driven too strongly by a belief in continuation of good performance, consistent with the “hot hand fallacy.” The hedge funds that investors choose to invest in do not perform significantly better than those they divest from. These findings are consistent with overreaction to certain types of information and do not support the notion that sophisticated investors have superior information or superior information processing abilities.

Original language	English
Pages (from-to)	4151-4172
Number of pages	22
Journal	Management Science
Volume	68
Issue number	6
Early online date	12 Aug 2021
DOIs	https://doi.org/10.1287/mnsc.2021.4067 https://doi.org/10.1287/mnsc.2021.4067
Publication status	Published - Jun 2022

Bibliographical note

Funding Information:
The authors benefited from extensive discussions with Francis de Vericourt, Ben Jacobsen, Yaakov Kareev, Anthony Lynch, Dimitri Vayanos, and Georg Weizsäcker. The authors thank Vikas Agarwal, Yong Chen, Frank de Jong, Alberta Di Giuli, Bart Keijsers, Simone Kohnz, Ignacio Palacios-Huerta, Tarun Ramadorai, David Stolin, Zheng Sun, Ashley Wang, Florian Weigert, two anonymous referees, and the associate editor for valuable and constructive comments and participants at the 2016 American Economic Association Annual Meetings, the 2015 China International Conference in Finance, the 2008 European Finance Association Annual Meetings, the 2007 American Finance Association Meetings, and the 2006 European Economic Association Annual Meetings. Dmitry Ilin and Zhou Ren provided excellent research assistance. Early versions of this manuscript were circulated under the title “Do Sophisticated Investors Believe in the Law of Small Numbers?”.

Publisher Copyright:
Copyright: © 2021 INFORMS

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abstract = "Cash flows to hedge funds are highly sensitive to performance streaks, a streak being defined as subsequent quarters during which a fund performs above or below a benchmark, even after controlling for a wide range of common performance measures. At the same time, streaks have limited predictive power regarding future fund performance. This suggests investors weigh information suboptimally, and their decisions are driven too strongly by a belief in continuation of good performance, consistent with the “hot hand fallacy.” The hedge funds that investors choose to invest in do not perform significantly better than those they divest from. These findings are consistent with overreaction to certain types of information and do not support the notion that sophisticated investors have superior information or superior information processing abilities.",

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Hedge Fund Flows and Performance Streaks: How Investors Weigh Information

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