The performance of hedge funds: Risk, return, and incentives

Hedge funds display several interesting characteristics that may influence performance, including: flexible investment strategies, strong managerial i ncentives, substantial managerial investment, sophisticated investors, and limited government oversight. Using a large sample of hedge fund data from 1988-1995, we find that hedge funds consistently outperform mutual funds, b ut not standard market indices. Hedge funds, however, are more volatile tha n bath mutual funds and market indices. Incentive fees explain some of the higher performance, but not the increased total risk. The impact of six dat a-conditioning biases is explored. We find evidence that positive and negat ive survival-related biases offset each other.