Hedge fund industry: is there a capacity effect?

For several months, investors and their advisors have been worrying about the profitability prospects for hedge funds.

Author(s):

Rudy Sillam

EDHEC Risk and Asset Management Research Centre

Modestly entitled the capacity effect, the analysis of the reasons behind the fairly disappointing performance in 2004 constitutes, if we believe those who are putting the argument forward, a serious calling into question of the alternative investment industry's value proposition. Alphas would be tending to become rarer, for two main reasons: - The significance of the sums drained into the alternative investment industry is making the implementation of niche arbitrage strategies more and more difficult (for example, convertible bonds or arbitrage on small stocks); more globally, the increase in operational volumes is reducing market inefficiency and market anomalies, which are allegedly the main source of performance for hedge funds. - The windfall represented by the remuneration model and the very strong growth in assets under management is attracting more and more managers, which is leading to a dilution of the talent available in the industry. The democratisation of hedge funds is making them increasingly dull. However, this pessimism doesn't hold up when we examine the facts. It is related more to the incapacity on the part of both investors and managers to understand or explain the true benefits of investment in hedge funds than to the capacity effect.

Type: Working paper
Date: le 04/07/2005
Research Cluster : Finance

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