The Ties That Bind

HandshakeWe know there is an extensive body of academic literature aimed at understanding hedge fund performance. However, while much of the research to date focuses on sophisticated models and metrics, there is one far less academic measure that explains hedge fund behavior: social ties. While a manager’s personal life isn’t typically something you’d read about in The Financial Analysts Journal, a group of academics have looked at social connections arising among managers sharing a common prior employment history as one factor that could explain hedge fund performance and behavior.

In their paper, “Birds of a Feather – Do Hedge Fund Managers Flock Together?”, Marc Gerritzen, Jens Carsten Jackwerth, and Alberto Plazzi contend that social ties developed while working in a prior industry or company can explain differences in hedge fund returns – that a manager learns valuable portable skills and strategies at his or her former workplace as well as common attitudes towards risk-taking.

Working with the universe of UK hedge funds, the authors find

“strong evidence that exposures to systematic risk factors (betas), abnormal performance (alphas), and idiosyncratic shocks (residuals) are more similar for hedge fund managers who are connected to each other through past employment at the same firm or past employment in the same industry. Results are unaffected by including a large number of controls such as fund characteristics and manager-specific details.”

In addition, the authors find that employment and social connections with the banking and pension industry positively and significantly influence hedge fund alpha, while connections within the investment management industry reduce alpha significantly.

You can download the full paper here.