On the Fund Selection Ability of Hedge Fund Investors

This paper studies the performance of the portfolio of hedge fund investors and the extent of investors' ability to exploit persistence patterns. Our evidence indicates that hedge fund investors are limited in identifying and directing their capital towards the best performers in the short run. They invest mostly in funds that subsequently perform poorly, underperforming the style index by more than 1% per quarter on average. Conversely, investors are fast and successful in de-allocating from the persistent losers, ensuring a disciplining mechanism for low-quality funds. We interpret our results as a consequence of the asymmetric response time of investors' purchasing and selling decisions. Our findings do not support the existence of smart money.