Do factor investing funds successfully capture the premiums associated with academic factors? We explore this question using the growing number of factor investing funds that seek to capture those premiums. While, on average, such funds do not outperform, we find that the factor investing funds with the portfolios that most closely match their academic factors—determined using our novel, holding-based ‘active characteristic share’ measure—significantly outperform those that less closely match. Furthermore, adjusting for stock size, we conclude that the answer to our question is “yes” for closely-matching factor investing funds, which net of costs duplicate the paper performance of the long side of academic factors.

We identify a parsimonious set of factors from a large set of candidates that can

potentially explain hedge fund returns, ranging from equity market factor, anomaly

factors, trend-following factors to macroeconomic factors. The resulting nine-factor model, including five anomaly factors, outperforms existing hedge fund models both in-sample and out-of-sample, with a significant reduction in alphas while maintaining substantial cross-sectional performance heterogeneity. Further analysis reveals evidence of strategy shifts by hedge funds over time, making necessary the addition of the anomaly factors. Our results suggest the importance of periodically updating factors for the hedge fund industry.