by HFBOA
22. November 2010 20:56
A recent white paper authored by Haim Mozes and Jason Orchard appears to set forth the proposition that smaller hedge funds (under $750 million in AUM) are less risky than larger hedge funds, and tend to generate greater alpha. "Alpha is an important source of hedge fund returns, and that alpha decreases as AUM grows. Thus, the larger a fund's AUM grows, the higher its systemic exposure and the lower its alpha generation and ability to exploit volatility, the worse it is likely to perform in a poor environment for equities and hedge funds. It is hard for hedge funds to find enough liquid, yet misunderstood assets to generate alpha." Mozes and Orchard seek to build upon the earlier work of Ammann and Moerth, which posited that hedge fund performance is negatively related to the amount of assets raised in the prior period. Interestingly, Mozes and Orchard's conclusions are directly contrary to the recorded capital flows throughout 2009-2010, which have been strongly in favor of the largest hedge funds.
Assuming that you agree with Mozes, Orchard, Ammann and Moerth, how does one go about finding smaller more nimble hedge funds? Investing in hedge funds with shorter track records and limited resources can be a bit of a gamble, so perhaps one could look to horse racing to offer some lessons. When it comes to wagering on horse racing, it seems that everyone has a system. Some folks bet on the Horse and some folks bet on the Jockey. I suggest that you look to place your bet on the best combination of Horse and Jockey, or "Hockey". Investors can't always be sure that the track record of an individual portfolio manager is wholly related to the investment acumen of that individual or the result of an institutional environment or team effort. Newer and smaller hedge funds where both attributes are present may offer the best chance for success.
When I hear someone ask, "Is this a good time to invest in hedge funds?", I view this as roughly equivalent to trying to time the market which no one has been able to do consistently. You will never know for sure whether it is a good time to initiate an investment, but you will definitely know it when you have missed the next upswing in the market or alternatively, caught a downdraft. The standard investment advice regarding diversification and dollar cost averaging also holds true regarding investing in hedge funds.
George Roeck, Chief Operating Officer & Chief Financial Officer, Charter Bridge Capital Management LP
Executive Board Member, HFBOA