Study Indicates Hedge Fund Managers Have Skill

By on May 15, 2010

Awhile back Social Science Research Network (SSRN) published a study by Wesley Gray, University of Chicago, and Andrew Kern, University of Missouri, indicating that hedge fund managers actually have stock-picking skills. Gray and Kern used the impressive results of stock picks posted at the Value Investors Club as proof of these managers skills.

Unlike previous research, which studies broad cross-sections of portfolio returns from mutual funds, or analyzes the suspect data from the various hedge fund data providers, we perform a clinical study of investment recommendations submitted to (VIC). VIC is a private-access club with a membership base that consists primarily of smaller fundamentals-based hedge fund managers and their associates. The environment of VIC provides an excellent opportunity to assess the stock-picking skills hypothesis.

Anyone can become a member of VIC, but supposedly many of the members are hedge fund managers. According to Gray and Kern there is no doubt that the members of VIC possess skill, which runs counter to what efficient market theorists propose.

We find overwhelming evidence that the hedge fund managers in our sample have stock-picking skills. The average one-, two-, and three-year raw returns of long recommendations submitted to the site over the January, 1 2000 to December 31, 2008 period are 17.11%, 45.02%, and 74.39%, respectively. After controlling for market risk, size risk, book-to-market exposure, and momentum risk, via a control portfolio, we find excess one-, two-, and three-year returns of 9.52%, 19.03%, and 23.60%, respectively. These results are all highly statistically significant and are well in excess of any management and performance fees these managers charge their investors.

At the VIC site it spells out the requirement to become a member:

Members must post a minimum of 2 ideas per calendar year (a maximum of 6 ideas) and must rate 20 ideas posted by other members. If a member is accepted after July 1, only 1 idea is required that year. Only high quality ideas will count towards the membership requirement. In the spirit of the club, please do not wait until the last moments of December to meet your annual requirements.

If the Gray and Kern study is accurate, it appears it may be worth the effort to join VIC.

Sources: SSRN, Value Investors Club

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