To Outperform the Market

Abstract

Voluminous research documents the fact that many active fund managers underperform the major market indexes. In general, long-only managers (mutual and pension funds) are more constrained than hedge fund managers. The more constrained a manager is, the smaller is his ability to exploit potential opportunities. Thus long-only investing can lead to positive risk-adjusted performance, although on average smaller than that of hedge fund investing. Hedge funds sell short, leverage, use derivatives, manage risk, and, among other things, do not manage their portfolios against a benchmark. That is, hedge funds import and use tools from outside of the long-only investing world and thus are able to outperform more consistently on a risk-adjusted basis.