Anomalies as New Hedge Fund Factors

Yong Chen, Sophia Zhengzi Li, Yushan Tang, and Guofu Zhou

♦ We identify a parsimonious set of factors from a large set of candidates for explaining hedge fund returns, ranging from equity market, anomaly and trend-following factors to macroeconomic factors. The resulting nine-factor model, including five anomaly factors, outperforms existing hedge fund models both in-sample and out-of-sample, with a significant reduction in alphas while showing substantial cross-sectional performance heterogeneity. Further analysis based on fund holdings confirms the model’s ability to capture returns from arbitrage trading. Overall, the anomaly factors help quantify hedge fund strategies and risk exposures and improve fund performance evaluation.

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