Fund selection, style allocation, and active management abilities: Evidence from funds of hedge funds’ holdings

Abstract

Abstract This study examines whether funds of hedge funds (FOHFs) provide superior before‐fee performance through managers’ fund selection, style allocation, and active management abilities. Using reported holdings of Securities and Exchange Commission–registered FOHFs, we find that FOHF managers have fund selection abilities, as hedge funds held by FOHFs outperform their style indices and over half of the individual hedge funds in the Lipper Trading Advisor Selection System (TASS) database. We also find that FOHF managers add value through active management of FOHFs’ holdings, while evidence on their style allocation abilities is mixed. Our findings suggest that FOHFs generate superior before‐fee performance and that FOHF managers’ skillset is broader than previously documented. Thus, our study helps explain why FOHFs continue to survive and suggests that FOHF fee structure reform merits consideration.