Pure return persistence, Hurst exponents and hedge fund selection – A practical note

In this note, we analyse whether measures of pure return persistence can forecast hedge fund performance, that is, whether they have the ability to identify hedge funds with superior performance in the remote future. Using a variety of Hurst exponent estimators (originating from rescaled range, detrended fluctuation, periodogram regression and average wavelet coefficient frameworks) and a rich sample of hedge funds, our study offers two important insights. First, only a small fraction of long-living funds shows significant return persistence whereas the majority is characterised by random behaviour. Second, high Hurst exponents (combined with low negative return ratios) can identify the funds with the highest Sharpe ratios, both in-sample and out-of-sample. Since these results are robust in a variety of settings, they imply that Hurst exponents can act as valuable hedge fund selection tools, not only for individual investors seeking the best funds but also for managers constructing funds of hedge funds.