How smart are the smart guys? A unique view from hedge fund stock holdings, Review of Financial Studies forthcoming

Compared to mutual funds, hedge funds prefer smaller, opaque value securities, and have higher turnover and more active share bets. Decomposing returns into three components, we find that hedge funds are better than mutual funds at stock picking by only 1.32 % per year on a value-weighted basis, and this result is insignificant on an equal-weighted basis or with price-to-sales benchmarks. Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find only weak evidence of differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill of hedge fund managers. (JEL G11, G23) An underlying assumption by many on Wall Street is that the best and bright-est migrate to the hedge fund industry. This assumption is often touted as a contributor to the sixty-five-fold increase in hedge fund assets under manage-ment from roughly $38 billion in 1990 to $2.48 trillion in mid-2007. While hedge funds typically are known for investing in a variety of positions, 42% of hedge funds (and 32 % of assets under management) are simply invested in long/short equity strategies.1 While the other activities of hedge funds are no