We provide novel evidence that hedge fund performance is persistent following weak hedge fund markets but is not persistent following strong markets. Specifically, we construct two performance measures, RET_DOWN and RET_UP, conditioned on the level of overall hedge fund sector returns. After adjusting for risks, funds in the highest RET_DOWN quintile outperform funds in the lowest quintile by approximately 7% in the subsequent year, whereas funds with better RET_UP do not outperform subsequently. The RET_DOWN measure can predict future fund performance over a horizon as long as 3 years, for both winners and losers and for funds with few share restrictions.

How do corporate bond mutual funds manage liquidity to meet investor redemptions? We show that during tranquil market conditions, these funds tend to reduce liquid asset holdings to meet redemptions, temporarily increasing relative exposures to illiquid asset classes. When aggregate uncertainty rises, however, they tend to scale down their liquid and illiquid assets proportionally to preserve portfolio liquidity. This fund-level dynamic management of liquidity appears to affect the broad financial market: Redemptions from the corporate bond fund sector lead to more corporate bond selling during high-uncertainty periods, which generates price pressures and predicts strong return reversals.