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The Value of Funds of Hedge Funds: Evidence from Their Holdings

Author

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  • Adam L. Aiken

    (School of Business and Engineering, Quinnipiac University, Hamden, Connecticut 06518)

  • Christopher P. Clifford

    (Gatton College of Business and Economics, University of Kentucky, Lexington, Kentucky 40506)

  • Jesse Ellis

    (Poole College of Management, North Carolina State University, Raleigh, North Carolina 27695)

Abstract

We examine the portfolio holdings of funds of hedge funds (FoFs) to identify the channels through which FoFs add value for their clients. FoFs offer access to a diversified portfolio of funds that would be costly for constrained investors to manage on their own. Although we find only limited evidence that FoFs exhibit skill when selecting hedge funds, we find strong evidence that FoFs make skillful termination decisions. After FoFs divest from a hedge fund, those hedge funds subsequently underperform and fail more often. Our evidence indicates that FoFs learn and skillfully process information about their portfolio funds after they become investors, enabling them to forecast poor future performance. Our study suggests that FoFs serve an important role as intermediaries in a market characterized by significant frictions and transactions costs. This paper was accepted by Wei Jiang, finance.

Suggested Citation

  • Adam L. Aiken & Christopher P. Clifford & Jesse Ellis, 2015. "The Value of Funds of Hedge Funds: Evidence from Their Holdings," Management Science, INFORMS, vol. 61(10), pages 2415-2429, October.
    • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:10:p:2415-2429
    DOI: 10.1287/mnsc.2014.2032
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    References listed on IDEAS

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    2. Frank Hespeler & Giuseppe Loiacono, 2017. "Monitoring systemic risk in the hedge fund sector," Quantitative Finance, Taylor & Francis Journals, vol. 17(12), pages 1859-1883, December.
    3. Joenväärä, Juha & Kauppila, Mikko & Kahra, Hannu, 2021. "Hedge fund portfolio selection with fund characteristics," Journal of Banking & Finance, Elsevier, vol. 132(C).
    4. Lee, Jennifer Eunkyeong & Cho, Hoon & Ryu, Doojin & Seok, Sangik, 2023. "Does performance-chasing behavior matter? International evidence," Journal of Multinational Financial Management, Elsevier, vol. 68(C).
    5. Vikas Agarwal & Yan Lu & Sugata Ray, 2016. "Under One Roof: A Study of Simultaneously Managed Hedge Funds and Funds of Hedge Funds," Management Science, INFORMS, vol. 62(3), pages 722-740, March.

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