We provide evidence of a significant relation between diversification and performance in the hedge fund industry. Measuring diversification across four distinct dimensions, we find a significant positive relation between hedge fund performance and diversification across sectors and asset classes. We show that on a risk adjusted basis, hedge funds that diversify across sectors and asset classes outperform other funds by an average of 1.1% per year. However, diversification across styles and geographies exhibits a significant negative association with hedge fund returns. Funds that diversify across styles and geographies underperform other funds by an average of 1% per year. For fund of hedge funds, we find a significant positive relation between performance and diversification across sectors. However, diversifying across asset classes and geographies is found to exhibit a negative relation with fund performance. Finally, we find that the motive to engage in diversification is consistent with managerial incentive structure in the hedge fund industry.

This paper tests the idea that financial regulation can impact performance persistence in the context of the hedge fund industry in 48 countries over the years 1994–2008. The data show evidence of three types of regulation influencing performance persistence: (1) minimum capital restrictions, which restrict lower quality funds and hence increase the likelihood of performance persistence, (2) restrictions on location of key service providers, which restrict human capital choices and hence tend to mitigate performance persistence, and (3) distribution channels, which make fund performance more opaque, decrease the likelihood of performance persistence. We do not find evidence that distribution channels, that promote fund presence to institutional investors, enhance performance persistence. Finally, we show differences in the effect of regulation on persistence by fund quartile ranking.