Decreasing returns to scale has eroded hedge fund performance persistence

This paper successfully replicates Kosowski, Naik and Teo (2007) and Jagannathan, Malakhov and Novikov (2010), two seminal studies of hedge fund performance persistence. The authors show that top funds continue to persist in a more recent sample, even when using novel “real-time” data that approximates an investor’s actual information set. The persistence available to investors has substantially weakened, however, and is only observed when using Kosowski et al.’s Bayesian alpha to predict performance. The authors identify the econometric source of the superiority of Kosowski et al.’s methodology and show that the decline in performance persistence is associated with decreasing returns to scale for superior funds.