Long/Short Equity Hedge Fund Investing

Abstract

Investors in long/short equity hedge funds frequently debate the relative merits of generalist and sector specialist hedge fund managers. Most of this debate has been anecdotal. Conventional wisdom favors specialists for their focus, dedication, and expertise in a single sector. Based on an empirical study, the authors found that sector specialists as a whole are not better off than generalists in terms of their exposure to systematic risks. After adjusting for volatility, the percentage of funds with positive performance Graham-Harvey measures is almost identical for generalists and sector specialists. They also present evidence that skilled managers are not an overwhelming majority within their sample of the long/short hedge fund managers. Finally, the study suggests that the more extreme the market dislocation, the lower the diversification benefits that average hedge fund managers can offer. On average, many sector specialists have higher correlation to relevant benchmarks than generalists in extreme market dislocations. However, all strategies fail to provide adequate downside protection under the worst market conditions. Furthermore, after accounting for market activities (such as volatility) in a specified market, their study shows, using various performance measures, that there is no major significant difference between generalists and sector specialists when observed as a group.