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The Value of Funds of Hedge Funds: Evidence from Their Holdings

Adam Aiken, Christopher P. Clifford () and Jesse Ellis ()
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Christopher P. Clifford: Gatton College of Business and Economics, University of Kentucky, Lexington, Kentucky 40506
Jesse Ellis: Poole College of Management, North Carolina State University, Raleigh, North Carolina 27695

Management Science, 2015, vol. 61, issue 10, 2415-2429

Abstract: We examine the portfolio holdings of funds of hedge funds (FoFs) to identify the channels through which FoFs add value for their clients. FoFs offer access to a diversified portfolio of funds that would be costly for constrained investors to manage on their own. Although we find only limited evidence that FoFs exhibit skill when selecting hedge funds, we find strong evidence that FoFs make skillful termination decisions. After FoFs divest from a hedge fund, those hedge funds subsequently underperform and fail more often. Our evidence indicates that FoFs learn and skillfully process information about their portfolio funds after they become investors, enabling them to forecast poor future performance. Our study suggests that FoFs serve an important role as intermediaries in a market characterized by significant frictions and transactions costs. This paper was accepted by Wei Jiang, finance.

Keywords: investment; financial institutions; markets; finance (search for similar items in EconPapers)
Date: 2015
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