Identifying Hedge Fund Skill by Using Peer Cohorts

David Forsberg, David Gallagher and Geoffrey J. Warren

Financial Analysts Journal, 2021, vol. 77, issue 2, 97-123

Abstract: We propose a cohort model that evaluates hedge funds against peer groups executing similar investment strategies formed by using return correlations. Our method improves the identification of skilled managers, as evidenced by a strong ability to explain hedge fund returns out-of-sample, with cohort alpha being more persistent than alpha based on the widely accepted seven-factor model. A hedge fund-of-funds analysis found significant performance enhancement from exposure to the best funds within each cohort. The cohort approach can be used to enhance the construction of hedge fund-of-funds portfolios by isolating strategy groupings as well as the best managers within each group.Disclosures: The authors have no conflicts of interest to declare. The content of this article reflects the views of the authors and not necessarily the views of BlueCove Limited. Editor’s Note: Submitted 2 September 2020.Accepted 6 January 2021 by Moshe Arye MilevskyThis article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the authors thanked the reviewers in their acknowledgments. Nicole M. Boyson and one anonymous reviewer were the reviewers for this article.

Date: 2021
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DOI: 10.1080/0015198X.2021.1875716

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