1. Hedge Funds: Performance, risk and capital formation William Fung David A. Hsieh Narayan Y. Naik Tarun Ramadorai Discussant Stephen J. Brown NYU Stern School of Business www.stern.nyu.edu/~sbrown

2. Major contributions of paper  Heterogeneity among funds of funds  Fund flow based on relative, not absolute return  Fund flow leads to an erosion of performance  Strong support for Berk and Green hypothesis  Triumph of mediocrity in fund performance

3. Substantial growth of funds of funds All TASS $US Funds of Funds

4. Substantial growth of funds of funds

5. Relative performance of Funds of Funds Source: CRSP and CISDM

6. Considerable heterogeneity among funds of funds All TASS $US Funds of Funds December 31, 2005 Mean $187.6 Million Median $62.6 Million

7. The Myth of Market Neutrality  Market neutrality is not a strategy  It is an outcome of a strategy  Hedge funds have significant market exposure  Fung and Hsieh (2003)  Smart money follows alpha

8. The Triumph of Mediocrity Secrist, H. (1933). The Triumph of Mediocrity in Business. Bureau of Business Research, Northwestern University, p.176.

9. The Failure of Mediocrity? Secrist, H. (1933). The Triumph of Mediocrity in Business. Bureau of Business Research, Northwestern University, p.176.

10. Diseconomies of Scale? Prior month assets under management 1 st quin tile 2 nd quintile 3 rd quintile 4 th quintile 5 th quintile All Funds t-value (large - small) Funds of Funds 7.31%9.12%8.61%9.77%10.28%10.08%2.56 0.1190.1830.2200.2720.3100.201 All hedge funds 13.74%14.11%12.39%11.16%10.72%10.97%-1.69 0.1340.1740.1770.1730.1700.160 All TASS $US Funds 1995-2004. Value weighted returns, Sharpe ratio in italics

11. Conclusion  Paper provides strong evidence  Heterogeneity among funds of funds  Funds flow to alpha, not absolute return  A triumph of mediocrity?  Evidence of diseconomies of scale is mixed