Hedge funds and international capital flows

Sammanfattning: This thesis consists of four chapters that investigate the performance and capital flows of hedge funds. The first two chapters of the thesis focus on hedge funds that have a pure emerging market strategy. Hedge funds should be well equipped to take advantage of opportunities in emerging markets due to their flexibility in investment strategy and lockup periods. However, the results show that, at the strategy level, emerging market hedge funds have only generated risk-adjusted returns in the most recent years of the sample period. Although emerging market hedge funds have performed poorly in the past, an important finding is the upward trend over time in performance. Given that other hedge fund strategies have a declining trend in alpha during the same period, the emerging market strategy may be where future alpha can be found. The third chapter investigates if there are capacity constraints in hedge fund strategies. The idea is that the alpha opportunities in the markets are limited. Thus, the more capital coming in to hedge funds, the higher competition for the investment opportunities. The findings reveal that mainly strategies that rely on liquidity in their underlying market show evidence of capacity constraints. That is, high past capital flows have a negative effect on current risk-adjusted returns. The last chapter investigates the out-of-sample performance of five allocation models relative to an equally weighted portfolio, when optimizing over hedge fund strategies. The findings show that for hedge fund investors the naive allocation model (1/N) with equal weights in each asset is not an efficient allocation. The risk-adjusted performance can be improved by using an optimal sample-based allocation model. Moreover, significant improvement in out-of-sample alpha can be made if the investor optimizes over non-systematic returns instead of total returns, which is an important results for investors seeking alpha.