New York, NY – Studies in recent years have shown that small emerging hedge funds have tended to outperform larger more well established funds. However, a recently published study by PerTrac Financial Solutions, a leading provider of asset allocation and investment performance analysis software, revealed that this trend showed some signs of reversing in 2008.
Smaller Hedge Funds Trail Larger Funds
According to PerTrac’s research, hedge funds with a smaller amount of assets under management underperformed funds that had a larger amount of assets under management. Funds with AUM of less than $100 million posted a loss of -17.03% in 2008, while funds with AUM between $100 mln and $500 mln recorded an average loss of -16.04%. Large hedge funds with AUM in excess of $500 mln experienced a loss of -14.10% for the year.
However, between 1996 through 2008, small funds performed best, with an annualized return of 13.05% versus 9.99% for medium-sized funds and 9.28% for large funds. Along with its stronger returns, the performance of smaller funds also showed greater volatility over the 13-year period with an annualized standard deviation of 6.96% versus just 5.92% and 6.05% for the medium-sized and large fund indexes, respectively.
Younger Funds Continue to Outperform
It is interesting to note that younger funds continued to outperform older more well-established hedge funds. Funds with a track record of less than 2 years lost -11.31% in 2008, whereas funds with 2 to 4 year track records posted much larger losses of -19.46%. Hedge funds that have been in existence more than 4 years recorded a loss of -17.85% in 2008.
From 1996 through 2008, younger funds have generated an annualized return of 15.74% while mid-age and older funds have trailed with annualized returns of 11.48% and 10.12%, respectively. Young funds have also fared best from a risk perspective over the long term; the young fund index has produced an annualized standard deviation of just 6.47% over the 13-year period while the mid-age and older fund indexes have proved more volatile with annualized standard deviations of 7.11% and 6.72%, respectively.
Consequences for Research
It is clear that a single year does not suggest that emerging funds are losing their luster. However, PerTrac executives suggest that the underperformance of small hedge funds could be a result of the fact that amidst large redemptions, smaller funds had to close out profitable positions – a move that hurt their performance, while larger funds were better positioned to handle these outflows without having to alter their investment strategy. Some also felt that a “flight to quality” in 2008 could have benefited larger funds at the expense of smaller hedge funds.
Regardless of the reason, this trend could have a negative impact on the alternative investment research industry – particularly if larger funds continue to get larger and smaller funds lose assets. Historically, smaller hedge funds have relied to a greater extent on unique, alternative research sources. By comparison, many hedge funds have moved to “building” their own research capability rather than relying on third-party providers as they get larger. This has been driven, to some extent, by the desire not to be overly reliant on external sources of research, as well as a desire to gain a proprietary edge over their competitors.
We have included the complete text of the press release discussing the results of the recent PerTrac study below.
PerTrac Study Analyzes the Impact of Hedge Fund Age and Size on Performance – Shows Younger and Larger Funds Reported Better Returns for 2008
New York – May 28, 2009 – PerTrac Financial Solutions (http://www.pertrac.com/) today released its third annual study that examines hedge fund returns, volatility and risk, based on a fund’s age and size. While previous research has confirmed the widely held belief that emerging funds tend to outperform older and larger funds, hedge fund performance in 2008 saw a partial reversal of that trend.
“Last year was a difficult one for hedge funds of all ages and sizes, but once again we saw younger funds outperforming older ones, confirming our findings from earlier studies,” said Meredith Jones, managing director at PerTrac. “However, when it comes to hedge fund performance as a function of fund size, we saw a reversal of the trend established from 1996 through 2007. During 2008, funds with the least assets actually performed the worst, while larger funds posted better returns.”
As in past studies, PerTrac conducted two different analyses: one based on a fund’s asset size, and the other based on a fund’s age. Monthly hedge fund returns were compiled from leading hedge fund databases and analyzed using the proprietary PerTrac Analytical Platform software. In each analysis, funds were re-categorized into one of three assets under management (AUM) size groups: up to $100 million; $100 million to $500 million; and over $500 million. The funds were also categorized into one of three age groups: up to 2 years; 2 to 4 years; and over 4 years. The mean fund return was calculated for each group in each month, creating three size-based monthly indexes and three age-based monthly indexes. Various risk and return statistics were calculated on the returns of each index to evaluate historical performance, and Monte Carlo simulations were run on each index to indicate probable ranges of future returns and drawdowns.
Small Hedge Funds Underperformed Larger Funds for the First Time Since Beginning of Study Data.
The study reveals that small funds averaged a loss of -17.03% in 2008, while medium-sized and large funds fared better, with average losses of -16.04% and -14.10% for the year, respectively. However, over the full history of the indexes, from 1996 through 2008, small funds performed best, with an annualized return of 13.05% versus 9.99% for medium-sized funds and 9.28% for large funds. Along with its stronger returns, the small fund index also showed greater volatility over the 13-year period with an annualized standard deviation of 6.96% versus just 5.92% and 6.05% for the medium-sized and large fund indexes, respectively.
“There are several possible reasons why small funds underperformed their larger peers for the first time ever in 2008. Due to losses across the board, hedge funds experienced heavy redemption requests last year. Larger funds generally have more cash on hand and greater access to lines of credit than small funds, better enabling them to handle redemption requests without compromising their portfolios’ performance,” noted Jones. “The recent market crash also appears to have prompted a ‘flight to quality’ among investors, with surveys indicating that hedge fund investors have become more interested in larger, more ‘institutional’ funds. So it’s likely that smaller funds had to deal with relatively greater redemptions than did their larger peers. We also noted a larger differential in the number of large managers reporting in both the prior and current studies, with a larger percentage of small managers participating in both updates. As a result, there is heavier survivor bias in the large fund group. Other possible reasons include infrastructure considerations, greater reliance on beleaguered prime brokers, and larger redemptions from poor performers pushing more managers into lower asset bands.”
“However, one year does not make a trend,” concluded Jones. “It will be interesting to see whether the small funds’ underperformance in 2008 proves to be a short-term exception to the rule or the start of an official trend.”
Young Funds Continued to Outperform Older Funds in 2008
An examination of the relationship between fund age and performance revealed no surprises for 2008. Hedge funds with the shortest track record continued their trend of superior performance last year as the young fund index lost -11.31% for the year compared to much larger losses of -19.46% and -17.85% by the mid-age and older fund indexes, respectively. Over the full history of the indexes from 1996 through 2008, young funds have generated an annualized return of 15.74% while mid-age and older funds have trailed with annualized returns of 11.48% and 10.12%, respectively. Young funds have also fared best from a risk perspective over the long term; the young fund index has produced an annualized standard deviation of just 6.47% over the 13-year period while the mid-age and older fund indexes have proved more volatile with annualized standard deviations of 7.11% and 6.72%, respectively.
The new study is the latest in a growing body of research produced by PerTrac Financial Solutions for the investment community. The company is devoted to advancing the study of hedge funds and other investments by publishing original research as well as providing free access to their PerTrac Analytical Platform software to academic professors, students, and selected researchers through the PerTrac Educational Use Program.
The research was originally published in the February 2007 issue of the investment journal Derivatives Use, Trading & Regulation (re-titled of as May 2007 to Journal of Derivatives & Hedge Funds). Ms. Jones authored the study, Examination of Fund Age and Size and Its Impact on Hedge Fund Performance.
Additional details on the updated study, including annual returns, performance statistics, and Monte Carlo risk simulations for each of the six indexes, are available from PerTrac Financial Solutions.
PerTrac Financial Solutions was founded in 1996 with the goal of creating a comprehensive suite of software solutions for investment professionals. Now an industry standard, PerTrac software is used by more than 2,000 clients in 50 countries, including banks, brokerage firms, consultants, plan sponsors, family offices, investment managers and funds of funds. The company’s flagship product, the PerTrac Analytical Platform, is now the world’s leading asset allocation and investment analysis software, used by approximately 1,700 firms worldwide. PerTrac CMS, which was part of its January 2006 acquisition of Whittaker Garnier, is another major component of the PerTrac Suite. PerTrac CMS is the investment industry’s leading tool for managing the client relationships and workflows associated with capital raising, investor relations, and investment management, and is used by nearly 300 alternative investment firms around the world. In January 2008, PerTrac announced the release of PerTrac Portfolio Manager, a unique software application designed to help funds of funds and institutional investors create, monitor and manage multi-manager portfolios of alternative investments. PerTrac P-Card, released in November 2008, is a revolutionary new investment data distribution and collection platform, which gives managers and investors the tools they need to share sensitive information directly, electronically and securely. PerTrac Financial Solutions is headquartered in New York with offices in London, Hong Kong, Tokyo, Reno, and Memphis. For additional information on the full suite of PerTrac products, please visit http://www.pertrac.com/.