Fri, 27/02/2009 - 06:02
Peter Urbani, chief investment officer of fund of funds manager Infiniti Solutions, argues that even amid the market turmoil of 2008, newer and smaller hedge fund managers significantly outperformed their older and larger competitors - in part because their size and agility enabled them to respond to the crisis more swiftly and decisively.
In a year when equities generated losses of 40 per cent and even the average prudentially managed balanced fund and many large endowments lost around 25 per cent, emerging hedge fund managers continued to deliver relative outperformance of between 180 and 400 basis points to average hedge fund returns.
Emerging managers - defined as less than 36 months old and with less than USD300m in assets under management at launch - lost between 16 and 18.2 per cent, compared with the industry's average loss of around 20 per cent, depending on which benchmark you use to measure the performance of the average established fund.
Infiniti Capital's own emerging manager products did even better, losing only around 12 per cent in 2008.
Whilst this was not the absolute return most investors hope for from alternative investments, it still represents a significantly better preservation of value than can be had from equities, which have continued their fall into 2009 while hedge funds have in general been flattish so far.
The reasons for the relative outperformance of newer managers remain simply that they are leaner and meaner and hungry for success. Many of the larger more established brand name hedge funds did very poorly in 2008, with some of the largest and oldest losing more than 50 per cent.
A significant part of this is due to the reduced flexibility of larger managers to change their portfolios, particularly in times of crisis. Numerous academic studies indicate that once a portfolio gets much larger than USD2bn, it starts to have a significant impact on the size and pricing of trades in all but the most liquid and deepest of markets. This inevitably translates eventually into mediocre performance.
Moreover, larger well-established hedge funds are less sensitive to client redemptions and may not have recognised the crisis proportions of the panic selling by investors as early as smaller firms, which are more sensitive to such moves by virtue of their size.
Larger funds are also less able to scale their operations and lay off staff or close offices as quickly as their more nimble juniors. This is a very significant issue because of the business model where the bulk of hedge fund fees are earned only above a high water mark. When coupled with client redemptions of up to 50 per cent for underperforming funds, it is easy to see how this could impact larger firms more materially.
Smaller firms, to be sure, have more business risk and with reduced assets under management this may now be a larger risk. However, their ability to reduce costs should more than compensate for this, although it is something Infiniti, as a fund of funds manager, watches closely.
It is therefore somewhat paradoxical that investors continue to fall for the allure of size and the false comfort of age. After all, who has ever really experienced better service from a larger organisation?
Perhaps somewhere on the other side of the current storm, boutiques will finally have their day - and in the process help reduce systemic risk as well.
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