Is there evidence for a capacity constraint in hedge fund strategies?

Henrik Rosenlund, Peter Moles

Research output: Working paper

Abstract

This paper examines whether hedge fund strategies are constrained by a capacity effect. Given that hedge funds pursue specialised investment strategies, which may not be readily scalable, there is a widely held view in the asset management industry that increases in assets invested in certain hedge fund strategies can be expected to lead to a crowding effect as more money chases the limited investment opportunities available. We make use of three performance measures to investigate the relationship between investment into hedge funds and excess returns. Using performance data, assets under management, and fund flows from 1991 to 2004, we examine whether returns for nine strategic categories and three groups of strategies were affected by asset flows and assets under management. The results indicate that strategies which may be subject to execution constraints are Equity Market Neutral, Equity Long-Short, and Merger Arbitrage. There is no evidence for constraints at the industry level or for the other strategy groups analysed. We conclude that, given existing data on hedge fund definitions, inflows, and performance measures, there is only limited support for the capacity
constraint hypothesis.
Original languageEnglish
Number of pages30
Publication statusPublished - 15 Oct 2006

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