Ilia Dichev (Emory): Hedge fund return disappoints

Today my guest is Professor Ilia Dichev. Prof Dichev is the Goizueta Chaired Professor of Accounting at Emory University. He has published a lot of research articles in top-tier journals such as TheJournal of Finance, Journal of Business, and American Economic Review, etc.

In 2002, Prof Dichev received the Notable Contributions to Accounting Literature Award, the highest research award in accounting. He is also the recipient of the 2007 Emerald Citation for Excellence, as the author of one of the top 50 articles in economics and business worldwide.

Today, our subject is: Are hedge fund investors taking higher risks and getting lower returns? I asked Prof Dichev some interesting questions, such as:

1) According to your calculation, between 1980 and 2008 (for about 28 years), a typical hedge fund investor receives an investment return of about 6% per year. During the same period, you get about 10.9% from buying and holding S&P 500, and5.6% from holding US T-bill. 

This seems so counter-intuitive. Are you saying that those sophisticated investors, such as pension funds, endowment funds, and sovereign wealth funds don't know what they are doing?

2) Your paper seems to show that on a TWR basis, hedge funds still can deliver outperformance. However, once we take the timing and magnitude of investors’ capital flow into account, that outperformance quickly dissipates, and investors actually don’t get any alpha from investing in hedge funds.

Now, let’s imagine that a hedge fund manager sees your paper, and tells you that: look, I am a very skillful manager, and I can generate alpha. But it is the investor who is so dumb and doesn’t understand how to invest in hedge funds. It is their fault not to get the outperformance, not me.They should have stuck with me from day one, and ride with me all the way till the end whether I am doing well or badly. Do you think it is a good argument?

3) ) Now let's imagine that another hedge fund manager comes to you, and says: ProfDichev, I like your research. It further verifies my point that I am smart, and the investors are dumb. Hedge fund investors always get in and out of the hedge fund that they invest at the wrong time. Therefore, to help them, I am going to implement a lock-up term, like most PE/VC funds do. Those who invest with me will be locked up for a minimum of 5 years. Plus, as the manager, I can trigger the “gating” term any time. Do you think that is a sensible argument derived from your study?

I hope you enjoy the conversation.

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