AbstractWe show that fund‐specific return skewness is associated with managerial skill and future hedge fund performance. Specifically, skewness in fund returns reflects managerial skill in avoiding large drawdowns. Using a new measure of investment skill that accounts for this managerial ability, we demonstrate that traditional performance measures underestimate (overestimate) managerial performance when returns exhibit positive (negative) fund‐specific skewness. Our new measure is particularly valuable during periods of economic crisis, when the annual risk‐adjusted outperformance is 5.5%.