Draft, November 2002 Entry and Exit: The Lifecycle of a Hedge Fund † Thomas Gimbel * , Francis Gupta ** & Dan Pines *** Introduction The problem of attrition among hedge funds is widely known and is a familiar topic of discussion in the hedge fund literature. 1 This article argues that the observed attrition in the industry may be the outcome of a natural selection among hedge funds. That is, a hedge fund with an idea to exploit inefficiencies in the market enters the industry and partakes in the profits as long as it is the only fund. With time, other incumbents with the same idea follow, thereby decreasing the share of any one fund’s profits. At the same time, the available pool of profits may also be shrinking as the market changes to get rid of the inefficiencies giving rise to the opportunities that generate the profits. Funds that are able to make profits faster and more efficiently continue to survive, while those that are inefficient, or unable to move fast enough incur losses and slowly exit the market. Since at any given time there are enough managers with new ideas and/or copycats, the industry continues seeing entry. If this hypothesis is true then the fact that in any given period, incumbents are actually exiting the market may be troubling from the shareholders point of view, but is in fact desirable from the industry’s perspective. Though this article presents a view of hedge fund industry in the context of industrial organization, i.e., the birth and evolution of an industry, to test our implications we will perform an analysis of the data at the individual fund level. In other word, we are taking a closer look at the trees to draw implications about the forest. The empirical observations that result, we hope, will be useful to both, the hedge fund manager and the hedge fund investor. Testable Implications of the Hypothesis If the hypothesis presented above is true, then the following observable empirical outcomes should also be true: (A) As long as there are profit-making opportunities, new managers will enter the industry. (B) Profit making is most rampant among new/younger managers and declines with time. 2 † This article is placed in the context of the generation, gestation and maturity of ideas, therefore, we would like to take this opportunity to thank Jennifer Coffey and Joseph Larucci for theirs. * Managing Director, Fund of Hedge Funds, Credit Suisse Asset Management, New York. ** Vice President, Strategic Advisory Group, Credit Suisse Asset Management, New York. *** Associate, Strategic Advisory Group, Credit Suisse Asset Management, New York. 1 Brown, Stephen J., William N. Goetzmann and Roger Ibbotson (1997). 2 By new/young managers we do not necessarily mean new into the industry. Rather, they could be very experienced managers with a new/young fund. CORE Metadata, citation and similar papers at core.ac.uk Provided by Research Papers in Economics