Sunday, 25 September 2016
Last updated 1 day ago
Feb 26 2009 | 12:00am ET
By Peter Urbani -- Newer hedge funds continued to out-perform their older more established brethren in 2008.
In a year when equities generated returns of -40% and even the average prudently managed balanced fund and many large endowments lost around -25%, emerging hedge fund managers (defined as managers that are less than 36 months old and have AUM of less than $300m at inception) continued to deliver relative outperformance of between +180 to +400 basis points (-16% to -18.2%) compared to average hedge fund returns of around -20%; depending on which benchmark you use to measure the performance of the average established Fund.
Infiniti’s own emerging manager products did even better losing only around -12% in 2008.
While this is not the absolute return most investors hope for from alternative investments, it still represents a significantly better preservation of value than can be had from equities, which have continued their fall into 2009, while hedge funds have in general been flat so far.
The reasons for the relative out-performance of newer managers remain that they are leaner and meaner and hungry for success. Many of the larger more established ‘brand name’ hedge funds did very poorly in 2008, with some of the largest and oldest losing more than 50%.
A significant part of this is due to the reduced flexibility of larger managers to change their portfolios, particularly in times of crisis. There are numerous academic studies that indicate that once a portfolio gets larger than $2 billion, it starts to have a significant impact on the size and pricing of trades in all but the most liquid and deepest of markets. This inevitably translates into eventual mediocre performance.
Moreover, larger well established hedge funds are less sensitive to client redemptions and may not recognize the crisis proportions of panic selling by investors as early as smaller firms who are more sensitive to such moves.
Larger Funds are also less able to scale their operations and lay off staff or close offices as quickly as their more nimble juniors. This is a significant issue because of the business model where the bulk of hedge fund fees are earned only above a high water mark. When coupled with client redemptions of up to 50% for under-performing funds, it is easy to see how this could impact larger firms more materially.
Smaller firms, to be sure, have more business risk, and with reduced AUM this may now be a larger risk. However, their ability to reduce costs should more than compensate for this although it is something Infiniti, as a fund of funds manager, watches closely.
It is somewhat paradoxical that investors continue to fall for the allure of size and the false comfort of age. After all, who has ever experienced better service from a large organization compared with a small one?
Perhaps somewhere on the other side of the current storm, boutiques will have their day, and in the process, help reduce systemic risk as well.
Peter Urbani is the chief investment officer of Infiniti Capital, a fund of hedge funds manager that pioneered the practice of charging only a performance fee. Originating from a Swiss based family office, Infiniti recently underwent a management buyout and is now entirely owned by its senior management and staff. The company runs a number of FoFs including two specialist mandate emerging manager funds on behalf of primarily institutional clients in Japan and Asia.