PerTrac study confirms that emerging hedge fund managers outperform older, larger funds

Date: Tuesday, May 20, 2008
Author: Hedgeweek.com

he latest edition of the Emerging Manager Study carried out by PerTrac Financial Solutions has confirmed the findings of the original study, released in March 2007, that emerging hedge funds perform better than older, larger funds.

'Our original study last year asserted that smaller, younger hedge funds outperform larger, older hedge funds, based on research covering the period between January 1996 and July 2006,' says PerTrac managing direct Meredith Jones. 'The new study, which includes data up to December 2007, confirms the original results.'

Data was compiled and analysed using the PerTrac Analytical Platform, an investment analysis and asset allocation software application used by more than 1,700 clients including banks, brokerage firms, consultants, pension scheme sponsors, family offices, investment managers and funds of funds.

Two different analyses were completed, one based on fund asset size, and one based on fund age. In each analysis, funds were re-categorised each month from January 1996 to last December into one of three size groups, up to USD100m, between USD100m and USD500m, and more than USD500m. They were also divided into three age groups, up to two years, between two and four years, and more than 4 years.

The mean fund return was calculated for each group in each month, creating three size-based monthly indices and three age-based monthly indices. 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.

In 2007, the average return of small funds in the index was 11.74 per cent, while medium-sized and large funds returned 10.27 and 10.22 per cent respectively. Both the annualised return and annualised standard deviation over the full length of the study, from 1996 through 2007, continue to be greatest for the smallest funds, at 16.01 per cent and 6.17 per cent, respectively.

The annualized returns were lowest for the largest funds, at 11.50 per cent, and the standard deviation was lowest for the mid-sized funds at 5.17 per cent. These figures suggest that, as funds get larger, monthly returns decrease in magnitude but also become steadier, or less risky.
 
The age-based indexes revealed a similar pattern. In 2007, the youngest funds returned an average of 15.02 per cent, while the mid-age and older funds returned an average of 9.45 and 9.53 per cent respectively. On an annualised basis over the full 12-year period, the average return of the young funds was 18.33 per cent, while the mid-age and older funds returned 14.55 and 12.84 per cent respectively.

Intriguingly, that the youngest funds exhibited a similar volatility profile to the older funds, with both groups posting annualised standard deviations of 5.95 per cent. The mid-age index ranked worst of the three on volatility, with an annualised standard deviation of 6.23 per cent.

'In addition to the original findings, we also sought to investigate the oft-cited phenomena of survivor bias within the groups,' Jones says. 'This is unfortunately extremely difficult to measure, given that funds stop reporting returns for any number of reasons, including fund closure, poor performance, or because they are no longer accepting assets.

'Instead, we compared the funds that comprised the last index month of the original study with those still reporting at the time of the updated study. Of the funds in the original sample, 74.1 per cent of the large funds appeared in the updated study indices, compared with 70.8 per cent of small funds. Therefore, although smaller funds are often accused of displaying higher closure and/or non-reporting rates, the actual difference is relatively small.'

The updated study is the latest research produced by PerTrac Financial Solutions for the investment community. The firm says it aims 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 software for academics, students and selected researchers under the PerTrac Educational Use Program.

Founded in 1996, PerTrac Financial Solutions also offers PerTrac CMS, a tool for managing client relationships and workflow associated with capital-raising, investor relations, and investment management used by nearly 300 alternative investment firms, and PerTrac Portfolio Manager, an application designed to help funds of funds and institutional investors create, monitor and manage multi-manager alternative investment portfolios. The firm has headquarters in New York and offices in London, Hong Kong, Reno, Memphis and Tokyo.