Hedge fund investors are missing out on some of the industry’s best talent.
Hedge funds operated by racial minorities generate alphas that are 4 percent higher than those operated by non-minorities, according to a recent research paper titled “Race and Hedge Funds.” Yet despite their stellar performance, Asian, Black, and Latino hedge fund managers still struggle to attract capital.
The study found that funds run by racial minorities raise $59 million, on average, for their first product — that’s 33 percent less than the money that white managers bring in for their inaugural launches. Once the funds are established, minority-owned hedge funds attract 3.1 percent to 3.6 percent less capital per year, according to the paper.
Minority hedge fund managers also face more barriers to entry. According to the study, these individuals are more likely to have attended selective schools, obtained post-graduate degrees, and worked at top-tier investment banks. Minority managers are also 11.5 percent more likely to have work experience at one of the top ten bulge-bracket investment banks, including JPMorgan Chase & Co., Bank of America, and Credit Suisse.
These findings imply that minority managers need to “jump through hoops” to get a foothold in the hedge fund industry, according to one of the paper’s authors, Melvyn Teo, a finance professor at Singapore Management University. “It’s very tough for them to actually rise through the ranks and become the portfolio manager or the chief investment officer,” he told Institutional Investor.
Teo and his co-authors based their conclusions on a study of more than 18,000 hedge funds globally. The authors, who also included Yan Lu from the University of Central Florida and Narayan Naik from the London Business School, collected racial information based on the managers’ surnames and conducted regression analysis on the funds’ performance data from 1994 to 2016.
Teo said one might expect to see less racial discrimination in the hedge fund industry compared to other asset management sectors, due to their emphasis on delivering outsized returns. “Hedge funds are supposed to be really focus on generating alpha,” he said. “That means the managers shouldn’t let any racial bias get in the way of delivering good performance.” But the results of the study suggest otherwise, he said.
Beyond delivering higher alpha, hedge funds operated by minority managers also generated portfolio returns that exceed those of non-minority managers by 6.6 percent, the study found. Their funds also had higher Sharpe ratios and information ratios, meaning their portfolios are better adjusted for risk and on track to beat market benchmarks.
The result of the paper, Teo concluded, is that the capital disparity between white and minority hedge fund managers is not “rational” or “justifiable” at all. “It is not driven by productivity differences between minorities and non-minorities,” he said.