Big, long-established hedge funds attract the most investment and attention. But younger and smaller funds perform better, on average, according to PerTrac Financial Solutions. There are logical explanations for this. Still, a few ofthe factors that could be at work raise tricky issues for hedge fund investors.
You’d expect younger and smaller funds—categories that often, but not always, overlap—to take more risk. Some of them are out to prove themselves, and it’s likely their investors are relatively few in number and have a higher risk tolerance.
Larger, established funds may attract relatively risk-averse institutional investors willing to accept more modest returns in exchange for lower volatility.
Smaller funds often say they are nimble and can profit from opportunities that don’t even register on big players’ radar. That logic also fits with the higher-return, higher-risk results reported by PerTrac for this group, compared with largerfunds. That’s fine as far as it goes. But it’s not just the younger and smaller funds’ absolute returns that seem to have beaten those of their bigger brethren. It applies to risk-adjusted results as well.
Could it be that some hedge fund managers lose their initial edge, becoming too comfortable or running out of ideas? Or maybe that, as funds grow, the most talented traders spend more time on management and less on investing, to the detriment of returns? Or simply that scale makes beating returns on stock markets and the like that much harder?
Any of these factors could be at work. It’s also possible that the results are affected by market trends and changes in hedge fund strategies over the 12 years analysed or by sampling biases.
Moreover, individual fund returns are widely dispersed around the average. And of course, different investors have different return requirements and attitudes towards risk.
Still, there are general lessons. Perhaps hedge fund investors shouldn’t rely too much on star managers with long track records. Throwing some cash at young, untested funds might be a smart move. And at the very least, investors should recognize that while big may often be safe, it is not always beautiful.