2008: The Year of the Small Hedge Fund Anomaly

A lot of funds of hedge funds focus almost exclusively on smaller, newer hedge funds. Whether it's due to the backfill bias that gives young funds apparent superpowers or simply because their managers are hungrier, newer hedge funds seem to outperform their older compatriots. Similarly, smaller funds (regardless of age) have generally performed better than larger ones.

Small Fry

Until now. Data analytics firm Pertrac, recently found that 2008 was an anomalous year since smaller hedge funds actually underperformed larger ones. As Pertrac’s Meredith Jones says in the company’s press release,

Last year was a difficult one for hedge funds of all ages and sizes…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.(our emphasis)

This is what the company found: (note: standard deviations calculated over 1996-2008 time frame)

The firm reckons that smaller funds may have been the victims of a flight to quality. This assumes, of course, that “quality” and “size” are synonymous.

Young Guns

But “quality” and “youth” continued to be synonymous last year. Pertrac found that, consistent with recent years, younger funds outperformed older ones.

Or, for the more graphically-inclined…

Saddle up

We are reminded of the following chart from a study about which we wrote last September that examined the interrelated effects of both age and fund size on performance. Regular readers might remember this saddle-looking chart showing how these factors work in tandem:

The authors of this study concluded that smaller funds of the same age do indeed tend to perform better as long as that age is relatively young. But older funds that remain small enjoy no such youthful vigour. In fact, older funds performed better if they were bigger, not smaller. The bottom line: Be small and young or large and old.

Comments

[onebir:]

The first pair of line charts shows small hedge funds underperforming larger ones in 08, the second one shows them performing less badly. They can't both be right... can they?

Jun 05 09:40 AM

[Maxe Paul:]

I guess the moral to the story is if you are small and young and don't blow yourself up you will become large and old!

Jun 05 11:34 AM