Monday, May 19, 2008

Age is key to hedge funds

(FT) Hedge funds show their best performance in their first two years, and produce lower returns as they get older and larger, a study shows.

The research, by Petrac Financial Solutions, software provider, includes data up to the end of last year – when many hedge funds suffered poor performance because of market volatility brought on by the credit crunch in the US.

The study finds that hedge funds less than two years old produced average returns of 11.7 per cent per year, while funds over four years old returned an average 10.2 per cent.

Returns at larger older funds tend to be more steady, however. This suggests that what managers may lose in performance, as time goes on, are made up for in risk management and their ability to navigate choppy, difficult markets without suffering huge swings in their returns.

An increasing number of investors is focusing on new managers in an attempt to secure higher returns. Hedge funds on average have seen their returns fall in recent years as the industry expands.

Many larger more established funds tend to be closed to new investment and can often have higher minimum investment criteria, making their barriers to entry greater than those for emerging managers.

But institutional investors, many of whom are trying to increase their exposure to the hedge fund sector, are often more concerned with steady returns that are uncorrelated with the markets rather than spectacular outperformance.

Two different analyses were completed as part of the research: one based on fund asset size and one based on fund age. In each analysis, funds were put into one of three size groups: up to $100m, $100m to $500m and over $500m.

They were also put into one of three age groups: up to two years, two to four years and over four years.

Various risk and return statistics were calculated to evaluate historical performance, while computer simulations were run to indicate probable ranges of future returns and drawdowns.

In 2007, the average return of small funds was 11.74 per cent, while the medium-sized and large funds returned 10.27 per cent and 10.22 per cent, respectively.

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