Selecting Prior Year’s Top Fund of Hedge Funds as This Year’s Choice

Abstract

Can investors select winning funds of hedge funds (FOFs) by merely assuming a simple trading strategy? Can historical information present insight on future returns? Financial theory presumes that stock markets are efficient and using any type of trading strategy will not be successful in the long-run. This article investigates a pure simple trading strategy to see if selecting last year’s top-performing FOFs as this year’s choice can outperform three FOF indexes and the S&P 500 Index. We further apply the strategy to the top-performing onshore and offshore funds, respectively, and compare them to the HFR Onshore and HFR Offshore indices, respectively. We generally find that selecting (up to) the six best performing FOFs is a winning strategy that outperforms both the market and the benchmark FOFs indices. There appears to be little benefit to over-diversifying in excess of this number. This finding applies both to onshore and offshore FOFs.