Should Investors Invest in Hedge Fund-Like Mutual Funds? Evidence from the 2007 Financial Crisis

Recently many mutual funds have created hedge fund-like products for marketing to retail investors. This study empirically examines the value added for investors during the 2007 financial crisis from hedge fund-like mutual funds, including 130/30, market neutral, and long/short equity funds. We find that based on the information ratio, all market neutral funds and top 75% of long/short equity funds have higher risk-adjusted returns than a passive index fund over the crisis period. However, based on either unconditional or conditional four-factor alphas, we find no evidence that hedge fund-like mutual funds in general add any value for investors, although there is evidence of genuine skills not purely due to luck by a few top 130/30 and long/short fund managers. The reason for the overall under-performance in the crisis period is that while short positions taken by these funds do generate alpha, the gain from their short positions is not sufficiently large to offset the loss from their long positions. Finally, the abnormal performance of short positions is found to be attributable to managers' characteristic-adjusted and industry-adjusted stock selection skills