The widely-held belief that emerging hedge funds perform better than older and larger funds has been reinforced by research from PerTrac Financial Solutions, creators of the PerTrac Analytical Platform, an investment analysis and asset allocation software suite.
'The study reveals that smaller and younger hedge funds tend to generate greater monthly returns than do older and larger hedge funds, although smaller funds also appear to be more volatile,' says PerTrac managing director and author of the study Meredith Jones.
'The study is useful to investors because it provides some broad guidelines on which funds are more likely to match their desired return/risk profile. While the information from this study can help investors know where to begin their search, they need to consider a number of factors when selecting a specific fund for investment.'
To undertake the study, entitled Examination of Fund Age and Size and Its Impact on Hedge Fund Performance, data was compiled and analysed using the PerTrac Analytical Platform software application.
Two analyses were carried out based on fund asset size and fund age. In each analysis, funds were categorised each month between January 1996 and July 2006 into three size groups of up to USD100m, between USD100m and USD500m, and more than USD500m, and into three age groups of up to two years, between two and four years, and more than four years.
The mean fund return was calculated for each group in each month, creating three size-based monthly indexes and three age-based monthly indexes. Various risk and return statistics were calculated on the returns of each index to evaluate historical performance while Monte Carlo simulations were run on each index to indicate probable ranges of future returns and drawdowns.
Among the size-based indexes, both the annualised return and annualised standard deviation were greatest for the smallest funds, at 15.46 per cent and 6.31 per cent respectively, and were lowest for the largest funds, at 11.93 per cent and 5.72 per cent respectively.
These results suggest that as funds get larger, monthly returns decrease in magnitude but also become steadier. Monte Carlo simulations of future returns produced a similar pattern, showing better probable long-term returns for the smallest funds but also larger probable loss-making periods.
The age-based indexes revealed a different pattern. While the index of youngest funds generated better returns over the 127-month period than either than mid-age or older funds, they also had the best risk profile of the three groups.
The index of youngest funds produced an annualised return of 17.5 per cent, compared with 11.84 per cent for the oldest index, and an annualised standard deviation of 5.97 per cent, compared with 6.39 per cent for the mid-age index, which ranked worst of the three on volatility.
Simulated future returns also showed the youngest funds outperforming on both return and risk, with the oldest funds likely to generate both the lowest long-term returns and the worst drawdowns.
The study is the latest piece of original research produced for the investment community by PerTrac Financial Solutions, which seeks to advance the study of hedge funds and other investments by publishing original research as well as providing free access to the PerTrac Analytical Platform to academics, students, and selected researchers through the PerTrac Educational Use Program.
The PerTrac Analytical Platform is used by more than 1,700 clients in 45 countries, including banks, brokerage firms, consultants, plan sponsors, family offices, investment managers and funds of funds. PerTrac CMS, which was part of the firm's acquisition last year of Whittaker Garnier, is a leading contact and information management system used by more than 250 alternative investment firms worldwide. PerTrac Financial Solutions is based in New York with offices in London, Hong Kong, Reno, Memphis and Tokyo.