Do hedge funds add value to a passive portfolio? Correcting for non-normal returns and disappearing funds

Abstract

Hedge funds have increased their assets under management rapidly in the last few years, partly owing to increasing inflows from large institutional investors such as pension funds and endowment funds. Not surprisingly hedge funds have also received increasing attention from the academic community. Non-linear factor models and option strategies have been used in the literature to explain hedge fund returns (see Fung and Hsieh, 2001; Agarwal and Naik, 2001; Mitchell and Pulvino, 2001; Amin and Kat, 2002). These papers provide insight into the risk involved in investing in hedge funds, and they are beneficial in developing benchmarks for hedge fund investment styles.