2007 Headlines
How to choose a hedge fund: Find out the manager's SAT
September 25, 2007 | Ithaca, NY Although much work has been done to understand risk and return properties for particular hedge fund strategies, little has been done to uncover the impact of manager characteristics on hedge fund performance. With top hedge fund managers' compensation reaching the million and even billion dollar mark, Xiaoyan Zhang, an assistant professor of finance at the Johnson School at Cornell University, along with co-authors Haitao Li of the Stephen M. Ross School of Business, and Rui Zhao now an associate at BlackRock, Inc., set out to explore which manager characteristics had the most impact on hedge fund performance.
Zhang and her co-authors built one of the most comprehensive databases of manager characteristics for the managers of more than 4,000 hedge funds active between 1994 and 2003. They collected information on the manager's age, total number of years working, number of years working at the specific hedge fund, composite SAT score for the manager's undergraduate institute, whether the manager has a CPA or CFA, and whether the manager has an MBA.
Across the different risk-adjustment benchmarks, sample periods, and types of funds, Zhang found:
- Managers from higher-SAT undergraduate institutions tend to have higher raw and risk-adjusted returns, and take fewer risks.
- Younger managers tend to have higher returns, and take more risks; likewise, managers with more experience tend to have lower returns, and take fewer risks.
- Younger and better-educated managers tend to attract more capital inflows.
- For managers following a "risk arbitrager" strategy, a 200 point increase in SAT leads to about 1.6% higher abnormal return per year, and managers with less work experience tend to have higher risk-adjusted returns.
- For managers who implement a "trend follower" strategy, the same 200 point increase in SAT leads to a 2.9% higher risk-adjusted return, but finds no relationship between work experience and results.
- There was not enough data to determine if holding a CFA, CPA or MBA impacted hedge fund performance
"Our results suggest that better-educated managers are better at their jobs and can achieve higher returns at lower risk exposures," commented Zhang. "It's also consistent with the hypothesis that younger managers have stronger incentives to work hard at their jobs and are more willing to take risks, and consequently tend to have better performance than older and more established managers."
