Hedge fund performance numbers are closely followed by investors and the media. Is past performance an indicator of future results? Of course past performance is no guarantee of future results, but past performance may correlate with future performance.
Vikas Agarwal is an associate professor of finance at Georgia State University and he has published a bunch of articles about hedge funds in the top journals such as Journal of Finance, Review of Financial Studies, and Journal of Financial and Quantitative Analysis. Vikas Agarwal and Narayan Y. Naik published a 2000 paper in Journal of Alternative Investments analyzing the quarterly performance persistence in hedge funds. They classified hedge funds as “winners” in each quarter if they manage to beat the average return in their strategy. Their paper answers the following questions:
What is the probability that a winner in one quarter will be a winner in the following quarter?
What is the probability that a loser in one quarter will be a loser in the following quarter?
The results support the thesis that there is short term hedge fund performance persistance. In their sample 54.3% of winners will keep outperforming the other funds in that strategy whereas 45.7% of winners will disappoint in the following quarter. The results are stronger for losers. 57% of losers will keep delivering disappointing results in the following quarter and only 43% of them will outperform. Past hedge fund performance is no guarantee of future success, but it may be an indicator.