A “small-cap bias” in hedge funds themselves?
May 21st, 2008 | Filed under: CAPM / Alpha Theory, Hedge Fund Industry Trends
If you’re in the hedge fund industry, you know the name Pertrac. These are the guys who make the ubiquitous software platform that many hedge funds use to analyse and report performance to their investors. Last March, the firm compared the performance of large ($500 million+), medium ($100 million-$500 million) and small (under $100 million) hedge funds to see if size determined success in Hedgistan. They also compared the performance of young (under 2 years old), middle aged (2-4 years old) and seasoned (4 years old +) hedge funds.
Earlier this week, the company announced the updated results of the same study. It came as no surprise to researchers that last year’s findings were reinforced. Young funds and small funds did better than their larger and older cousins. The chart below appears in the firm’s press release:
You don’t need to be a finance Ph.D. to see the parallels between this research and the work of Eugene Fama and Kenneth French on the “small-cap bias”. Apparently, small cap stocks aren’t the only small things that tend to outperform.
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Another possibility is that it’s easier to slip a small fund into a database after a successful development phase in the nursery, while unsuccessful small funds get merged into other strategies or not reported at all. Ergo, smaller funds — especially, younger ones, which, since I didn’t RTFA, may or not have been corrected for in the work.
$2 billion funds, of course, don’t just appear out of nowhere and few of them disappear without some parting shot.
Also, managers of small funds may feel they have almost nothing to risk and take higher bets: a small fund is either dramatically more successful than its peers or is condemned to eternal unprofitability on any asset-based fee schedule. Ergo, higher risks taken (with clients’ money).
Just speculation, in case it’s not obvious from a close read.
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