Not only skill but also scale: Evidence from the hedge funds industry

Maher Kooli and Min Zhang

International Review of Financial Analysis, 2022, vol. 83, issue C

Abstract: This paper empirically tests a two-levels model of decreasing returns to scale using a sample of hedge funds. The two-levels model assumes that a fund's gross alpha is a decreasing function of both the fund scale and the style scale measured by the aggregate size of peers in the hedge fund style. We find that a fund-level model underestimates the impact of diseconomies of scale on the gross alpha by 55 basis points. The results indicate that managers should consider the constraints imposed by the style scale when optimizing their portfolio sizes. We also provide evidence that hedge funds did not invest at their optimal amount and confirm that skill and the ability to resist decreasing returns to scale are two important components of selecting hedge fund performers.

Keywords: Hedge funds; Decreasing returns to scale; Performance; Skill (search for similar items in EconPapers)
JEL-codes: G11 G23 J24 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:83:y:2022:i:c:s1057521922001910

DOI: 10.1016/j.irfa.2022.102230

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