Chase hedge fund winners, but only so far

Momentum is everywhere and it is a strong foundation for any active management strategy, but there is an alternative view that chasing winners is a fool's game whereby buying of tops and bailing on losers will be a easy path to failure. The answer is somewhere between these extremes as presented by the Common Fund in their August 2014 white paper Chasing Winners: The Appeal and the Risk.

Their paper which evaluates hedge funds shows that chasing hedge fund winners, those with performance persistence, is a good thing except you do not want to chase too long. The longer you hold a winner, the more likely you will underperform.  Winners get stale. This is consistent with the research on momentum in stocks and in asset classes. In fact, you should do a quick evaluation, hold the winners for under a year and then move on. Active management of hedge fund winners makes a difference.  

Nevertheless, their work provides additional insight on skill based or alpha managers. Choosing those who are hot may make sense, but finding those with skill is even better. The winners or momentum strategy may be picking up trends in the underlying asset classes or beta while skills through alpha generation may transcend a trend. It is an interesting perspective which needs further exploration. Most likely, finding winners with skill is the best of both worlds but the rarest of managers.