Share Restrictions, Risk Taking and Hedge Fund Performance

This paper examines the impact of share restrictions on the risk-taking and on the performance of hedge funds using the Hedge Fund Research (HFR) database. Share restrictions, in the form of longer lockup as well as notice and redemption periods, provide flexibility for the managers. Our results suggest that this flexibility allows hedge fund managers with lockup provision to take an excess risk, which is not compensated, when performance is measured as a unit of the risk taken by the manager. Specifically, we find that typical hedge funds with a lockup provision deliver 5.6-6.6% (3.8-5.4%) lower Fung and Hsieh (2004) appraisal ratios (Sharpe ratios) compared to their peers without a lockup provision. The results remain consistent even after controlling for various database biases, alternative risk and performance measures, and non-linearities in hedge fund returns.