Hedge fund performance - size matters in a crisis

There has been a good amount of research on the effect of size and performance within the hedge fund category. This research suggests that there may not be strong economies of scale. In fact, the  opposite may be the case. The most recent research from the Cass Business School in London shows that there is a negative correlation between size and performance. Bigger is not better. The more interesting and unique part of their research is what happens in a crisis. The authors find that small firms do better than large firms during financial crisis. You might say that smaller firms are more nimble than larger firms. They are able to move positions and take advantage of opportunities faster than large firms. 

This work is not for a small period but represents a 20 year analysis of both funds that have survived and closed. It is interesting that their data set shows that 80% of funds have died over this period. There are few survivors in the hedge fund area; nevertheless, the data also shows that performance declines with age. While this age analysis holds over the entire period, the post-2009 period shows a positive relationship between performance and age. It looks like the industry is changing with more established firms being able to survive and still produce good returns. 

The tables below show the key results from the study for both size and age Another interesting conclusion is that the size and age relationship is not consistent across hedge funds. The performance will differ by hedge fund style. At the extreme, long/short equity has the largest negative effect while the relationship in managed futures is actually positive. When looking at the tests through a fixed effect panel data, this positive behavior, however, is not present.

This work again confirms that looking for the right hungry talent will work in favor of investors. It is worth looking at smaller managers to gain their performance premium before they get too large.