This paper aims to contribute to the active-versus-passive investment debate by examining whether hedge funds generate market outperformance and, more broadly, whether they create value beyond persistent alpha. While hedge funds are often perceived as vehicles for superior returns, their continued growth despite high fees raises the question of what explains their attractiveness if consistent outperformance is absent. The study therefore evaluates both alpha generation and alternative sources of portfolio value, including diversification benefits and downside-risk mitigation.
The analysis is based on a comprehensive sample of 3,828 hedge funds with monthly observations from February 2014 to January 2024. Market-adjusted performance is estimated using established asset-pricing frameworks, including Jensen’s alpha model, the Fama–French multi-factor model and the Fung–Hsieh hedge fund factor model. Beyond average alpha estimates, the study examines the cross-sectional distribution of excess returns, market beta exposure and implications for portfolio efficiency and risk-adjusted performance.
The results show no consistent evidence of market outperformance: average alpha estimates are statistically indistinguishable from zero across the sample. However, important distributional patterns emerge. Over the 10-year horizon, more hedge funds achieved positive than negative excess returns. Moreover, hedge funds exhibit relatively low and often asymmetric market betas, indicating that their value lies less in persistent alpha generation and more in enhancing portfolio efficiency through diversification and downside-risk mitigation. These benefits are particularly relevant during periods of market stress.
Hedge fund data sets often exclude funds that closed or stopped reporting, which may lead to upward-biased performance estimates. The authors explain in the paper how they approach this potential survivorship bias.
Investors and asset managers should recalibrate expectations: hedge funds should not be viewed primarily as vehicles for beating the market, but as effective instruments for improving risk-adjusted performance and providing resilience in diversified portfolios. This is especially valid during market stress.
This paper extends the active-versus-passive debate by shifting the focus from alpha generation to the broader risk–return profile of hedge funds. While prior literature predominantly evaluates hedge funds on their ability to beat the market, this study highlights their context-dependent role as instruments for improving risk-adjusted performance and portfolio resilience. By emphasizing distributional patterns and beta characteristics rather than average alpha alone, the paper offers a refined perspective on the economic function of hedge funds in contemporary investment strategies.
