Decomposing Hedge Fund Returns: What Hedge Funds
Got Right for the Past 20 Years

Abstract

This article identifies three drivers of hedge funds’ strong risk-adjusted returns over the past 20 year. First, hedge funds had a number of factor exposures which generated positive returns but did not increase overall portfolio risk, due to how these factors correlated with other exposures. Second, hedge funds timed several of their risk exposures very sensibly. Third, hedge funds used their superior funding ability to exploit opportunities that offered positive expected returns but below that of the risk-free rate. Most investors ignore these opportunities due to the high opportunity cost, but hedge fund managers, who have superior ability to fund cheaply (e.g., Fung and Hsieh [2011]), do not.