Mispricing chasing, market competition and hedge fund performance

This thesis investigates the impact of market competition on hedge fund performance over hedge funds’ lifecycle and their market mispricing chasing behaviour.

There has been a rapid growth in hedge funds in recent decades. Hedge Fund Research, Inc. estimates that the total capital in the hedge fund industry amounted to almost $3.235 trillion globally in 2018, with over 10,000 active hedge funds. In comparison there were only 1,200 hedge funds managing $200 billion in 1997. As the hedge fund market becomes more competitive, there has been growing interest from both academia and investors in how hedge funds deliver a superior performance under increasing market competition. 

In this thesis, we first examine the effect of market competition on the hedge fund lifecycle performance from several different perspectives, including (a) timeseries market competition effect on hedge funds’ inception and failure; and (b) crosssectional market competition, to assess individual hedge fund performance. Furthermore, to investigate the hedge fund managers’ mispricing chasing behaviour under market competition, we employ the mispricing timing skills models to measure the hedge fund manager’s market mispricing timing skills in the equity market and fixed income market. In addition, we introduce a fund classification model to classify individual funds into different types in terms of their mispricing timing skills. 

The empirical findings of this thesis show that market competition in the timesseries analysis induces more hedge fund inception and hedge fund failure. In addition, market competition subsequently leads to superior hedge fund overall performance in the early stages of the hedge fund lifecycle. However, a cross-sectional market competition will decrease the individual hedge funds’ overall performance, together with several other factors, including hedge fund age, hedge funds’ risk-taking preference and hedge fund market co-movement. Finally, we also find that hedge fund managers can time the stock market mispricing and bond market mispricing opportunities by adjusting their market exposure during the underpriced and undervalued market periods.