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Beware Falling for Hedge Funds With Important-Sounding Names

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What’s in a name? For hedge fund investors, sometimes a warning sign.

Hedge funds often choose names with words that reflect authority, stability and power — i.e. words with gravitas. Now a report from researchers at the University at Buffalo and Finland’s University of Oulu finds that investors should beware.

Funds with gravitas-laden names “have lower returns, alphas, sharpe ratios and manipulation-proof performance measures, higher volatilities and maximum drawdowns as well as higher probabilities of extinction than the funds with lower name gravitas,” according to the report, which examined nearly 18,000 hedge funds globally that on average manage about $160 million. These funds also tend to charge higher management fees and lower incentive fees.

And yet investors tend to fall for those types of names nonetheless — especially with words related to economics, nations and politics. Adding one word with gravitas to a hedge fund’s name can bring in about $227,120 more, on average, each year, the report found.

‘Psychology Effect’

“What we document is the relatively puzzling fact that investors chase gravitas in the name of the fund itself even after we control for the fund’s manager and for the fund’s performance” as well as investor due diligence, according to the report, which was co-authored by Cristian Tiu and Juha Joenvaara.

That said, as investors discover the fund’s real returns and abilities, they respond less to gravitas, the report found. Also, funds that demand higher minimum investments, are larger and have been around for longer tend to see investor inflows less tied to name gravitas.

“The name, of course, has no bearing on the potential or actual returns generated by a hedge fund, but it does have a psychology effect as to what the name connotes,” said Tim Ng, chief investment officer at $28 billion Clearbrook Global Advisors, which invests about $2 billion in hedge funds. “Names with gravitas suggests particular qualities that you as an investor or human being could be attracted by. On the flip side, a name that conjures up a negative historical event, name, etc., does give you an initial pause, but in the end superior performance from a risk/return perspective will always win the day.”

Report co-author Tiu sits on the investment committee of the University at Buffalo’s endowment and said he isn’t swayed by words.

“I’d be embarrassed if we were influenced by fund names,” he said.

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