Do Agency Problems Predict the (Under-) Performance of Private Hedge Funds?

We show that earning non-hedge fund income is associated with lower future hedge fund performance. Specifically, generating non-hedge fund income reflects weakened alignment between the incentives of hedge fund management firm owners and the interests of investors. Using a hand-collected database of UK hedge fund firm private company filings, we demonstrate that owner-manager-investor weak alignment funds (WAFs) underperform their peers, as the fund managers they employ have less investment skill. Information revealed by the fund flow-performance relationship indicates that the clientele of WAFs is less responsive to new information on performance. This finding is particularly important for regulators as it is consistent with these firms having less sophisticated professional investors as clients.