Hedge Fund Illiquidity, Age, and Performance

Abstract

This article shows that hedge fund performance is positively related to funds’ exposure to illiquid assets. Therefore, because older funds and funds with larger increases in assets under management tend to invest less in illiquid assets, these funds tend to have weaker performance. The results for fund age hold for every major category of hedge fund and across the time period examined. In addition, the results hold even when controlling for the size of hedge fund assets. The age effect is strongest for volatile funds that are focused on security selection. The first implication of the article is that hedge fund investors who focus on older funds with long track records may generate disappointing results, especially if these funds are still rapidly growing their assets. A second implication is that investors considering investing in older funds and in funds that have grown considerably need to establish whether the fund has the same mix of liquid and illiquid investments it had in prior years. A third implication is that liquid-alternative products are unlikely to perform well, because they cannot hold the types of illiquid investments that are strongly associated with hedge fund performance.