The role of market timing and security selection in hedge fundsÕ returns to investors in South Africa

Abstract

This research study investigates the ability of hedge funds to deliver alpha. But more significantly, the research goes further and investigates the role of security selection and market timing, i.e. skill, in delivering this alpha to investors. Empirical work regarding the ability of hedge funds to deliver alpha, as well as whether hedge funds have the ability to make superior security selections and time the market, have been mixed. The JensenÕs alpha measure is utilised to investigate the level of alpha that hedge funds are able to deliver. The performance attribution model as introduced by Brinson, Hood and Beebower is employed to calculate the returns attributable to security selection and market timing. The monthly returns of 30 South African hedge funds are analysed for the period between February 2005 and February 2017. Findings show that overwhelming alpha is present, with 28 of the 30 hedge funds in the sample delivering positive alpha. While the alpha can be attributed to both security selection and the market timing activities of hedge funds, 24 of the 30 hedge funds were able make superior security selections and time the market.