Finding Fortune: How Do Institutional Investors Pick Asset Managers?

Abstract We propose and test a framework of private information acquisition and decision timing for asset allocators hiring outside investment managers. Using unique data on due diligence interactions between an institutional allocator and 860 hedge fund managers, we find that the production of private information complements public information. The allocator strategically chooses how much proprietary information to collect, reducing due diligence time by 18 months and improving outcomes. Funds selected by the manager outperform those not selected by 9$\%$ over 20 months. The outperformance relates to the allocator learning about fund return-to-scale constraints and manager skill before other investors.