| Extensive theoretical and empirical work on portfolio investments has sought to understand the roles of incentives, liquidity, alternative investment strategies, leverage, and active concentrated investments in explaining performance. The first chapter of this dissertation takes a new approach to understanding these issues by comparing mutual funds and hedge funds. We demonstrate the strong direct and indirect limitations that mutual fund regulation places on these instruments. In contrast, the relatively unregulated hedge fund industry makes extensive use of these investment tools. Using a combination of several large hedge fund and mutual fund databases, this chapter shows that these regulatory constraints hinder mutual fund performance. We find evidence that hedge funds outperform mutual funds during 1988--1995. We attempt to link these regulatory and performance differences between hedge funds and mutual funds. Specifically, the impact of regulatory related characteristics (incentive fees, lockup periods, illiquid securities, short selling, derivatives, turnover, leverage, and concentration) on hedge fund performance is assessed. Incentive fees and lockups are the most powerful determinants of performance. These features explain most of the performance differential between hedge funds and mutual funds. We find no consistent evidence that regulatory constraints on short selling, derivatives, turnover, and leverage handicap mutual fund performance.; The second chapter investigates performance persistence in hedge funds during 1988--1995. We employ a non-parametric test that compares each fund to the median-performing fund in successive periods, and a parametric test that emphasizes the magnitude of performance. Persistence among raw returns is strong but fleeting, and is not present beyond one quarter. Persistence is observable at annual intervals when we adjust for risk, and is pronounced for the parametric test. We expand our study of risk-adjusted persistence along several dimensions. Risk-adjusted persistence holds after controlling for differences in fund style. The relative strength of the non-parametric and parametric tests is reconciled by very strong persistence among top and bottom quartile funds. Conditioning on multiple years of over- or underperformance also intensifies persistence. Finally, we test the impact of several elements that may influence persistence. Past performance, incentive compensation and limited redemption opportunities for investors all play a role in driving persistence. |
