Under one roof: a study of simultaneously managed hedge funds and funds of hedge funds

We examine the simultaneous management of hedge funds and funds of hedge funds. Hedge fund firms can choose to simultaneously offer a fund of hedge funds. Similarly, fund of hedge funds firms can simultaneously offer a hedge fund. We find that although superior past performance and larger size drive the decision to become simultaneous for hedge fund firms, past flows drive the decision for fund of hedge funds firms. The effects of simultaneity are also different. When hedge fund firms start funds of hedge funds, we find evidence of value creation, driven by better management of economies of scale and cross learning. In contrast, fund of hedge funds firms starting hedge funds destroy value due to expansion beyond core competencies and agency problems. We find that firms learn about their competencies in the two business lines and discontinue underperforming simultaneity arrangements to focus on the business where they perform better. Keywords: hedge funds, funds of hedge funds, agency problem, simultaneous management History : Received February 12, 2014; accepted November 18, 2014, by Gustavo Manso, finance. Published online in Articles in Advance June 15, 2015.
1. Introduction Around a quarter of hedge funds and about a half of funds of hedge funds (FOFs) are managed by firms that simultaneously offer hedge funds and FOFs. Yet, [...]