Flows, Price Pressure, and Hedge Fund Returns∗

We study how capital flows affect hedge fund returns. The contemporaneous relation is positive: funds with high flows outperform funds with low flows during the month of the flows. This immediate reaction, combined with feedback trading, gives rise to a cycle: flows exert price pressure, this effect on returns induces more flows, and these flows cause further price pressure. The cycle is so strong that it takes almost two years before a full return reversal is witnessed. This flow-return cycle also contributes to the observed persistence in hedge fund performance. The impact of flows on returns also has implications for perfor-mance evaluation: roughly one third of the estimated hedge fund alphas are due to flows