Xiaoqing Eleanor Xu and Anthony L. Loviscek
MBS hedge funds have outperformed the Lehman MBS Index by an average of 210 basis points annually from 1992 through 2003. By comparison, MBS mutual funds have underperformed the Lehman MBS Index by an average of 141 basis points per year. This contrast in performance persists even after adjusting for total risk, as measured by Sharpe ratios. It also persists on a market risk-adjusted basis. Using CAPM single-index, illiquidity-adjusted, market-timing, and various multi-index and multi-factor models, we find that Jensen’s alpha is consistently negative and significant for MBS mutual funds but positive and significant for MBS hedge funds.