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7 March 2022 Financial Analysts Journal

Capacity Constraints in Hedge Funds: The Relation Between Fund Performance and Cohort Size

  1. David Forsberg
  2. David R. Gallagher
  3. Geoffrey J. Warren
Extending prior research that used peer cohorts to identify skilled managers, the authors find that hedge fund performance has a significant negative correlation with cohort size but an inconsistent correlation with fund size.
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We provide evidence consistent with scale diseconomies for hedge funds being related to the aggregate assets pursing particular investment strategies. This study extends research by Forsberg, Gallagher and Warren who identified skilled managers with persistent performance by forming peer cohorts of hedge funds using return correlations. Our analysis shows fund performance had a significant negative relationship with cohort size, while the relationship with the fund size is inconsistent across specifications but evident where funds faced limited competition. We also document a weaker relationship between performance and inflows where funds faced less competition, suggesting that cohort structure might influence propensity to accept assets.

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