PerTrac Financial Solutions has released the results of its updated Emerging Manager Study, originally released in March 2007, confirming again the widely held belief that emerging hedge funds perform better than older, larger funds.
“Our original study, released early last year, asserted that smaller, younger hedge funds outperform larger, older hedge funds, based on research spanning January 1996 to July 2006. The new study, which includes data through December 2007, confirms the original results,” says Meredith Jones, managing director, PerTrac.
Data was compiled and analysed using the PerTrac Analytical Platform software application.
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 through December 2007 into one of three size groups: up to $100 million; over $100 million and up to $500 million; and over $500 million. They were also categorized into one of three age groups: up to 2 years; 2 to 4 years; and over 4 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.
In 2007, the average return of small funds in the index was 11.74%, while the medium-sized and large funds returned 10.27% and 10.22%, respectively. In addition, 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% and 6.17%, respectively. The annualised returns were lowest for the largest funds, at 11.50%, and the standard deviation was lowest for the mid-sized funds at 5.17%. Those statistics suggest that, as funds get larger, monthly returns decrease in magnitude but also become steadier, or less risky.
The age-based indexes revealed a somewhat similar pattern. In 2007, the youngest funds returned an average of 15.02%, while the mid-age and older funds returned an average of 9.45% and 9.53%, respectively. On an annualized basis over the full 12-year period, the average return of the young funds was 18.33%, while the mid-age and older funds returned 14.55% and 12.84%, respectively. It is interesting to note, however, that the youngest funds exhibited a similar volatility profile to the older funds, with both groups posting annualised standard deviations of 5.95%. The mid-age index ranked worst of the three on volatility, with an annualized standard deviation of 6.23%.
“In addition to the original findings, we also sought to investigate the oft-cited phenomena of survivor bias within the groups. This is unfortunately extremely difficult to measure, given that funds stop reporting returns for any number of reasons, including fund closure, poor performance, no longer accepting assets, etc. Instead, we compared the funds that comprised the last index month of the original study with the funds still reporting at the time of the updated study.
“Of the funds in the original sample, 74.1% of the large funds made an appearance in the updated study indices, compared with 70.8% of the small funds. Therefore, although smaller funds are often accused of displaying higher closure and/or non-reporting rates, the actual difference is relatively small,” says Jones.
The updated study is the latest in a growing body of research produced by PerTrac Financial Solutions for the investment community. The company is devoted to advancing the study of hedge funds and other investments by publishing original research as well as providing free access to their PerTrac Analytical Platform software to academic professors, students, and selected researchers through the PerTrac Educational Use Program.
The research was originally published in the February 2007 issue of the investment journal Derivatives Use, Trading & Regulation. Jones authored the study, Examination of Fund Age and Size and Its Impact on Hedge Fund Performance.