Holdings Concentration and Hedge Fund Investment Strategies

This article examines the risk-return performance of concentrated positions of hedge funds in large-cap and small-cap stocks. The research shows that small-cap stocks in which hedge funds have concentrated positions earn higher future returns than those that are not part of hedge funds' concentrated holdings. Also, stocks that are part of the concentrated positions of hedge funds display higher downside risks and relatively large downside returns during periods of market turmoil. The results presented indicate that hedge fund managers are skilled in making equity investments under different degrees of market efficiency. The authors' findings have two practical implications: (1) hedge funds that hold concentrated positions in small-cap stocks may outperform their peers and (2) investors may be able to improve the performance of their equity portfolios by monitoring hedge funds' positions in small-cap stocks.