Passive Hedge Funds H/T Matt Levine Mikhail Tupitsyn Monash Business School Paul Lajbcygier Monash University - Department of Banking & Finance August 10, 2015 Abstract: We show that most hedge fund managers are passive, not active. Active management should be manifest through nonlinear exposure to the systematic risk factors that drive hedge fund returns. In order to demonstrate managerial skill enhanced performance should accrue as a consequence of active management. Using generalized additive models we find that approximately two-thirds of Hedge Funds exhibit only linear factor exposures and hence are “passive”. What’s more such “passive” managers tend to outperform “active” managers. Finally, we also show that many “active” managers, despite initial nonlinear risk exposures, eventually become “passive”. Passive Hedge Funds - Introduction The question at the heart of this study is simple: do most hedge fund managers generate returns through managerial skill? The answer, according to our work is no. Most hedge fund managers rely on “passive” linear risk exposures to generate their returns and, paradoxically, they outperform most “active” managers which try to deploy skill. To demonstrate skill, a hedge fund manager must generate enhanced performance through active management. Such skill should be manifest through nonlinear exposure to the systematic risk factors that drive hedge fund returns and as a... More