Hedge fund managers with skin in the game really
do yield the best results, according to research from NYU and
When managers invest in their own hedge funds, the funds
earn more and are less sensitive to performance-driven flows,
said Arpit Gupta, an assistant professor at NYUs Stern
School of Business, and Kunal Sachdeva, a PhD candidate at
Columbia Business School, in a paper this month.
Greater insider investment better aligns incentives
between managers and investors and induces managers to limit
the size of their fund, resulting in higher alphas, they
said. When funds rely on outside capital, managers are
compensated primarily from managerial fees and leave little
value to outside investors.
Raising more capital lowers returns for existing investors
a fact that the researchers said managers internalize
when they are investing their own money. As a result, funds
with higher levels of inside capital are comparatively small
and outperform on a risk-adjusted basis, according to Gupta and
In examining data from research providers such as HFR,
eVestment, EurekaHedge, and CISDM, as well as regulatory filings, the
authors found that funds with no outside capital earned 4.3
percent higher excess returns annually compared to funds with
only outside investments.
When more than 20 percent of funds were owned by insiders,
managers did not raise more capital even after periods of
positive excess performance and continued to outperform
longer than funds that did see additional inflows.
By limiting fund inflows in periods in which funds
experience high returns, insider funds are able to maintain
persistently high excess returns over time, the authors
wrote. In doing so, funds are foregoing management fees
on additional capital in lieu of greater excess returns on
privately invested capital.
In other words, their compensation stems from performance
rather than fees tied to the amount of assets managed, better
aligning incentives of managers and outside investors,
according to the paper.
Funds which rely more on insider money outperform
funds which do not eat their own cooking,
Gupta and Sachdeva said.