Bigger isn’t always better for hedge funds

Published 06 December 2012 05:14, Updated 06 December 2012 09:40

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If you’re looking to put money with hedge funds, young and small may be the way to go, according to a report that has collated returns from hedge funds around the world.

The average small fund outperformed the average mid-sized fund and the average large fund every year since 1996, except for 2008, 2009 and 2001, according to research firm Pertac.

The researcher defines small as having less than $US100 million in assets under management; mid-sized $US100 million to $US500 million; and large, more than $US500 million.

The Pertec research also finds that young funds (started within the past two years) outperformed the average “middle-aged” and “tenured” funds for 14 out of the 16 years since 1996. In traditional “long-only” investing, investors tend to seek out well-resourced investment managers with a proven track record of at least five years or more.

“We call it the Dumbo effect,” the head of alternatives research at Zenith Investment Partners, Daniel Liptak, says.

“The very small and very large funds tend to do well and [the] medium-sized tend to underperform,” he says.

Liptak says new funds tend to be hungrier and nimbler, while large funds tend to be able to pay for infrastructure.

Hedge funds have been struggling to replicate their pre-GFC performance.

The golden period up to 2007 gave
the industry its reputation for earning big performance fees on outsized returns.

The annual returns for all three hedge fund age and size categories were negative for the 16 years to 2012, with the average mid-sized and mid-aged funds fairing the worst, returning minus 2.95 per cent and plus 4.99 per cent respectively, according to Pertac.

Hedge funds performed best when the industry was smaller and contained fewer funds, according to Simon Lack, a New York-based hedge fund provocateur who spent 23 years at investment bank JPMorgan selecting hedge funds to invest in. He says that, on average, hedge funds have underperformed even risk-free US Treasury bills over the long term.

In his tell-all book released earlier this year, The Hedge Fund Mirage, Lack says it’s hard to know how well hedge funds actually perform because the industry’s use of asset- and time-weighted measurements tend to overstate returns.

Also, while most investor capital has flooded in over the past 10 years, hedge funds performed best when the industry had far fewer assets under management than it does now.

Further to the findings in his book, Lack tells BRW the conventional wisdom of diversification used in investing generally doesn’t apply when it comes to investing in hedge funds.

He says there are a small number of quality hedge fund managers but investing in a range of managers brings investors closer to the median asset class return, “which you don’t want”, he says.

“Therefore, you only want to have more like 1 per cent invested [with hedge funds], not 20 per cent.”

Applying generalities to the asset class is unfair, says Liptak, who emphasises that certain hedge fund strategies work at certain times.

He says that in the current market, credit-based strategies will be doing well, whereas a managed futures strategy, which traditionally has excelled in volatile markets, may not.

Liptak tracks an index of 12 Australian “market neutral” funds (which have the same value in long bets as short bets) which, he says, have returned 14.6 per cent annualised over the past 10 years, with a variance in returns year to year of 5 per cent.

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