Why do experienced hedge fund managers have lower returns

Abstract Several theories of reputation suggest that managers’ career concerns affect their decisions. We investigate these theories by studying the behavior of hedge fund managers over their careers. In contrast with mutual fund managers who incur more risk over time, hedge fund managers take on less risk over time. This finding is consistent with certain industry characteristics which imply that experienced managers have “more to lose” in personal wealth, current income, and reputation should their funds fail. Most important, the propensity of experienced managers to reduce risk explains their underperformance. These results have implications for fund selection and incentive contract design. * Purdue University, Krannert Graduate School of Management, West Lafayette, IN 47907. E-mail: nboyson@mgmt.purdue.edu. Phone: (765) 496-7877. This paper is a revised version of an earlier paper entitled, “How are hedge fund manager characteristics related to returns, risk, and survival?” I would like to thank Vikas Agarwal, Richard Brealey, Stephen Brown, Steve Buser, Mike Cliff, Mike Cooper, Dave Denis, Diane Denis, Jean Helwege, David Hirshleifer, Kewei Hou, Andrew Karolyi, Bing Liang, Bernadette Minton, John McConnell, Narayan Naik, Karen Wruck, and Rene Stulz (my advisor), and seminar participants at The Ohio State University, Purdue University, and London Business School's Centre for Hedge Fund Research and Education. All remaining errors are my own.