Investor Concentration, Flows, and Cash Holdings : Evidence from Hedge Funds

We show that when only a few investors contribute a substantial portion of a fund's equity, the probability of large liquidity-driven fund outflows increases because investors' idiosyncratic liquidity shocks are not diversified away. Using confidential regulatory filings, we find the five largest investors on average own 50% of a hedge fund. Consistent with our predictions, we confirm that high investor concentration hedge funds are more likely to experience large liquidity-driven outflows. Such funds hold more precautionary cash and implement other portfolio adjustments that help absorb outflows, but result in lower risk-adjusted returns. We find no evidence that hedge funds with a concentrated investor base impose longer share restrictions