Abstract
Institutional investors face various leverage and short-sale restrictions that alter competition in the asset management industry. This distortion enables unconstrained investors with high volatility targets to extract additional income from constrained institutional investors. Using a sample of 1,938 long–short equity hedge funds spanning 15 years, the authors show that high-volatility funds charge higher fees and deliver lower net-of-fees Sharpe ratios than do their low-volatility peers. This evidence could be interpreted as a situational rent extraction or as a service compensation. Conversely, increased volatility could result from a manager’s ambition to deliver large net information ratios after accounting for a high fee structure.
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