Why you should avoid the hottest hedge fund hands

Pershing Square Capital Management CEO Bill Ackman pauses during an interview in New York.
Scott Eells | Bloomberg | Getty Images

Investors who don't have money with Pershing Square Capital Management are likely salivating at the hedge fund's industry-leading 26 percent return from January through July.

But investing with Bill Ackman and other top-performing managers after a great run is probably a bad idea, according to a new study of long-term hedge fund industry performance.

A white paper by Commonfund, which manages nearly $25 billion for close to 1,500 endowments, pensions and other institutions, shows that putting money with the hottest hedge fund managers can work in the short term, but that sticking with them for three years or more is worse than picking managers at random. Picking up losing hedge fund strategies can even produce slightly positive performance.

"Not only does positive-return persistence tend not to work as a selection strategy, but it is especially ineffective in the medium-to-long-range horizons that institutional investors may prefer, and indistinguishable from a strategy of selecting losers," authors Kristofer Kwait and John Delano wrote.

Kwait and Delano found that picking winning hedge funds produced returns of 13.29 percent after 18 months, versus an average of 10.62 percent for all funds. But the same group held for 36 months gained the same as the average; over 48 and 60 months, they rose just 9.49 percent and 8.48 percent, respectively.