Should You Invest In Emerging Market Hedge Funds

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 findings in this paper show that, at the strategy-level, emerging market hedge funds have only been able to generate risk-adjusted returns in the most recent period when analyzing data between 1994 and 2004. Also, the strategy in question does not present the investor with any benefits that would be valuable in a hedge fund portfolio. There is weak evidence of persistence in risk-adjusted returns at the fund-level. However, good performance is not rewarded with capital inflows. This reduces incentives for managers to exert effort and may even deter skillful managers from entering the strategy. Consistent with these results, investors have reallocated their money to other hedge fund strategies. 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 (Fung et al. 2007), perhaps emerging market funds are where future alphas can be found.