Capital Flows and Hedge Fund Regulation

Abstract

This article introduces a cross‐country law and finance analysis of the regulatory impact on the level of capital flows and the sensitivity of capital flows in response to prior performance (i.e., the “flow‐performance” relationship) in the hedge fund industry. The data indicate that distribution channels in the form of wrappers (securities that combine different products) mitigate flow‐performance sensitivity. Distribution channels via investment managers and fund distribution companies enhance flow‐performance sensitivity. Funds registered in countries that have larger minimum capitalization requirements have higher levels of capital flows. Funds registered in countries that restrict the location of key service providers have lower levels of capital flows. Further, offshore fund flows and calendar effects evidenced in the data are consistent with tax factors influencing capital flows. The findings are robust to selection effects for offshore registrants, among other robustness checks.