Hedge funds' secret may lie in luck

The best hedge fund managers tend to find profits in short-term, contrarian bets. That's the finding of a study published this year by Russell Jame of the University of Kentucky and set to be presented next month at the American Economic Association's annual meeting in Philadelphia. Investigating an industry that has grown to over $2 trillion from $38 billion in 1990, Mr. Jame found the top 30% of hedge funds outperform rivals by a statistically significant 0.25% per month over the subsequent year, indicating their superior performance persists. Star hedge funds secure profits over short periods, with more than 25% of an annual outperformance occurring within a month after a trade. The profits are also often made when managers have bet against the prevailing market view. The winning funds are net buyers of so-called growth stocks, which are those of companies whose earnings are forecast to grow faster than the market average. They also don't trade more frequently or more profitably prior to corporate earnings' announcements, undermining any idea that insider trading explains how they make profits. Mr. Jame's sample featured 74 hedge fund management companies managing money for 253 different clients from 1999 to 2010. (Bloomberg News)