Smaller Hedge Fund Managers Lead in Performance

Emerging hedge fund managers who run newer, smaller funds consistently outperform their larger, brand-name cousins, and do so with less volatility as well.

That’s the word from the recent Emerging Managers Summit in New York City, sponsored by Opal Financial Group, according to an article on Admittedly, they have a vested interest in getting the word out about emerging fund managers. Yet their findings are backed up by several empirical studies from third parties.

Northern Trust released a November 2010 study that concluded the smallest investment firms outperformed the largest hedge funds (as well as the S&P 500) over the five-year period ending June 30, 2010. They compared large and small firms in both up and down markets. Smaller firms delivered “dramatically” better performance in down markets, and won in up-market periods as well. The Northern Trust researchers founds that smaller funds have a less bureaucratic working environment, greater motivation and greater flexibility to deal with changing market environments.

HFR Asset Management’s report, “Emerging Manager Out-Performance: Alpha Opportunities from the Industry’s Newest Hedge Fund Managers,” concurred. HFR says “emerging managers are generally smaller and well suited to adapt to changing market conditions and exploit new opportunities…new ideas are more likely to generate superior returns than are copycat ideas.”

Harcourt Investment Consulting AG, a firm with $4.7 billion in assets under management, also found that younger, smaller hedge funds consistently outperform older funds, in their Strategy Focus Report.

There are a number of possible reasons. First, emerging hedge fund managers often have unique or niche strategies that stem from a star manager’s particular expertise. This contrasts with larger funds, where because of their size, they may drift into a multi-strategy approach and may have a half-dozen younger, less experienced portfolio managers.

Star managers launching their own funds may have more of their own “skin in the game”. This gives them the motivation and incentive to generate superior returns with less risk. While a larger, multi-billion dollar hedge fund manager may simply want to increase his fund’s size, and thus increase management fees.

What’s your opinion? Would you rather work for a smaller, newer hedge fund than an established giant fund? Which do you think presents more opportunity at this stage of your career? Add your comments below.

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