Hedge fund managers are nothing if not innovative. Take Davide Erro, chief investment officer of the Hong Kong-based Turiya Advisors Asia, who delighted his investors by returning 17.5% of their capital investment. Turiya further pleased investors by returning north of 20% through the first 11 months of 2014.

Erro reasoned that Turiya was growing at a faster pace than he had anticipated (a 20% return will encourage inflows), and that by returning capital, the fund would be in a better position to pursue returns. Erro, in effect, postulates that reducing assets under management (AUM) in some way positions a fund to achieve greater returns. Huh?

AUM vs. Performance

Despite the lack of consensus on the definition of a small hedge fund, there is no shortage of debate on the topic of comparative performance—small versus large.

Academic studies of hedge fund performance simply ignore the absence of a definition and, rank the hedge funds being studied according to AUM, defining the top one-third as large, the middle one-third as medium and the bottom one-third as small. That is an appropriate solution when dealing with a finite universe of hedge funds but, woefully inadequate when discussing the industry as a whole.

That said, the preponderance of academic studies conclude that small hedge funds outperform their larger rivals and there is abundant anecdotal evidence to support this conclusion.

Is Turiya Small?

It is not—at least according to Bloomberg’s 100 Top Performing Large Hedge Funds. Turiya, at $3 billion in AUM, would nestle comfortably in this nest of over-achievers. However, Turiya is conspicuously absent from the list even though it is larger than two-thirds of the funds that comprise Bloomberg’s top 100 “large” hedge funds … and not by reason of performance! Only six of the one hundred funds on the list boasted returns exceeding 20%. This begs the question: Why wasn’t Turiya on Bloomberg’s list?

In fairness, Erro did not define Turiya as small or large. Rather, he implied that it was larger than he wanted it to be, hence the return of capital to his investors.

Perception is Reality

By voluntarily shrinking assets under management, Erro created the illusion of being a small hedge fund. But why would a CIO do this? Because institutional investors have a decided preference for smaller hedge funds with a track record of robust returns.

In one brilliant stroke, Erro secured the loyalty of his current investors and, by creating the perception that his fund was small, through the unprecedented action of voluntarily returning 17.5% of assets under management to his investors, Davide Erro garnered financial media attention and priceless free publicity for his relatively obscure Hong Kong-based fund.

Only time will answer the question posed, but one thing is certain, the future of Turiya Advisors Asia will be fascinating to watch play out in the coming months. Perhaps it will be in the Bloomberg top 100 for  2015.

 

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Record breaking index growth (e.g. the S&P 500’s positive percentage change stood at 11.39%) in the year ending 2014,  highlighted a comparatively lackluster year for hedge fund performance, which, on average, showed modest gains averaging around 3.5%.

Despite a less than banner year in terms of returns, a Pyramis Global Survey suggested that only one-third of U.S. institutional investors were disappointed with returns, and CALpers announcing a $4 billion redemption – yet the hedge fund industry continued to expand assets under management at an 8.35% annual clip.

Let’s take a look back at some of the interesting twists and turns in the hedge fund saga through the past year.

2014Quarters One through Three

The first quarter saw increased scrutiny on SAC Capital Advisors, LLC, as the SEC’s insider trading probe heated up. This stain on hedge funds’ public image was further exacerbated by the media’s year-long string of stories featuring the criminal exploits of worst actors in the industry.

Meanwhile, hedge fund managers tried to gauge the implications of the JOBS Act, which promised to lift the general solicitation ban.

The year’s second quarter saw hedge funds testing investment opportunities in the tech startup waters, while Deloitte puzzled over continued investment inflows into hedge funds and, the 8th SAC Capital Advisors employee was found guilty of insider trading.

Meanwhile, mutual funds were raiding hedge funds for talent in an effort to develop mutual fund offerings that mimicked hedge fund investment strategies. Direxion also flattered hedge funds through imitation, with its plans to launch an EFT that mirrored hedge guru investments.

June opened with the SEC’s first whistleblower award of the year, as the SEC paid out $437,500 to each of two un-named recipients.

With first-half results in the record book, hedge funds continued to trail the performance of the S&P 500, while attracting investor cash to the tune of $72.2 billion through the first 5 months of 2014, bringing total assets under management to a record $2.8 trillion.

The financial media continued to hammer hedge funds for their intractable stance on Argentine debt and CALpers announced redemption plans that rekindled the controversial subject of hedge fund management and performance fees.

The Final Stretch

In the waning weeks of 2014, slanted stories of rampant hedge fund closures surfaced, such as this one in Business Insider. Garnering much less press was the flip side of the coin; the equally significant number of hedge fund start-ups.

While year-end results are not yet finalized, it is certain that the hedge fund industry has baffled all its critics and will achieve something north of $3 billion in assets under management. However, equally indisputable, is the fact that hedge funds will once again underperform as compared to broader markets for the 5th straight year.

The coming year is certain to be a challenging one for the industry. Regulatory concerns, data management and reporting concerns, cyber security and, a sober evaluation of fee structures all loom large in the collective mind of hedge fund managers. As for 2014, let us remember that past performance does not guarantee future results.

 

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