Hedge Fund Mean Reversion

Our earlier articles explored hedge fund survivor (survivorship) bias and large fund survivor bias. These artifacts can nearly double nominal returns and overstate security selection (stock picking) performance by 80%. Due to these biases, future performance of the largest funds disappoints. The survivors and the largest funds have excellent past nominal performance, yet it is not predictive of their future returns due to hedge fund mean reversion, a special case of reversion toward the mean. Here we explore this phenomenon and its mitigation.

We follow the approach of our earlier pieces that analyzed hedge funds’ long U.S. equity portfolios (HF Aggregate). This dataset spans the long portfolios of all U.S. hedge funds active over the past 15 years...