Small Hedge Funds Outperform the Large, Especially In Crisis Times : Research

Smaller hedge funds tend to outperform their larger counterparts, especially during times of crisis, according to a recent research paper.

The research is relevant to pension funds because pensions often select managers based on the advice of consultants, who often recommend large-ish hedge funds – and, although some pension funds are opting to go smaller, most take their consultants’ advice.

From CIO Magazine:

In a study of hedge fund size and performance between 1994 and 2014, City University London’s Andrew Clare, Dirk Nitzsche, and Nick Motson found investors were better off at the smaller end of the scale.

According to the study, the largest decile of funds returned an average of 0.61% per month, with a standard deviation of 0.66% and a Sharpe ratio of 0.62. The smallest decile, however, generated an average return of 0.74%, a standard deviation of 0.72% and a Sharpe ratio of 0.74.

Smaller funds outperformed their larger counterparts for all but three of the 20 years covered by the study, the paper found, with correlations intensifying for periods following the collapse of the tech bubble and the global financial crisis.

[…]

Additionally, hedge fund managers do not age well, the study claimed—at least in terms of performance.

“One would hope that a hedge fund’s performance would—like a vintage wine—improve with fund age, as the fund’s managers become more experience at managing their funds and strategies,” the paper said.

Despite these expectations, data revealed that older funds produced lower returns compared with their less-established counterparts. And the relationship was particularly negative during 1996 to 2002.

Read the paper here.

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