Hedge Funds: Performance, Risk Management, and Impact on Asset Markets

Abstract

Hedge funds are dynamic, versatile, opaque, and, according to BarclayHedge, their assets under management have nearly doubled from $2.6 trillion in 2015 to $4.9 trillion in 2021. In the recent decade, whether hedge funds have delivered superior performance is in debate. Researchers conclude differently depending on the sample of hedge funds available for investigation. Recent research has made significant advances in understanding factors that contribute to or impair fund performance and in identifying potential sources of managerial skill. These include changes in disclosure requirements, examination of timing ability, the role of short selling and derivatives use, the effect of fund and manager characteristics, and applications of more advanced econometric techniques. Recent research has also examined different risks hedge funds are exposed to and the risk management practices of hedge funds. Particularly, studies have focused on systematic risk, liquidity risk, and financial intermediary risk stemming from trading in the market and interacting with other market participants. With greater availability of novel data such as regulatory filings (e.g., Form PF), studies have improved understanding of types of risks hedge funds take on and implications of risk taking on fund performance, factors related to heterogeneous risks, and risk management process of hedge funds. Lastly, recent research has also studied the role of hedge funds in the asset market. Hedge funds possess stronger incentives, are less constrained, and are nimbler in their trading than other institutional investments. Studies have investigated the important role of hedge funds in contributing to price discovery, market efficiency, and liquidity in financial markets. Evidence suggests that the ability of hedge funds to arbitrage or provide liquidity depends on market conditions and funds’ funding conditions.