Hedged Mutual Funds and Competition for Sources of Alpha

Hedged mutual funds flourished following the 2007-2009 financial crisis. They became particularly popular with financial advisors because of their alleged downside protection. Did these funds deliver what they promised? We examine the performance of these funds with a focus on the post-2009 period. While they generated positive alphas before the crisis, we find that this abnormal performance vanishes in the post-2009 period as their strategies became increasingly crowded due to the above popularity. We show that flows to hedged mutual funds are negatively related to investor sentiment, implying that investors use these funds as a hedge against downside risk.