Systematic risk in hedge funds

We document that hedge funds with lower systematic risk exposures have higher Sharpe ratios. These funds are more successful: they are able to charge higher fees and manage more assets. When pressed with inflows, fund categories on average do not lose their ability to find investments bearing no systematic risk. By contrast, individual funds experiencing inflows above and beyond their category average increase their systematic risk exposures. The tradeoff between performance and the degree to which systematic risk exposures explain the returns of hedge funds has implications for the latter’s transparency: the risks taken by outperforming hedge funds cannot be understood solely from their monthly returns.