If there is one point that we can agree on, no study of hedge fund size relative to hedge fund performance has been conducted that is capable of defending its conclusions effectively against all-comers. The nature of the industry, in terms of its diverse strategies, varying degrees of management competency and numberless external market forces, precludes the possibility of bullet-proof conclusions.
There Are Things We Know and Things We Don’t Know
We know that no consensus definition exists for small and large. As a result, no valid conclusions can be drawn by comparing studies with differing definitions. For example, if study “A” caps small hedge funds at $500 million and study “B” caps them at $100 million; significant overlap exists between small and large funds rendering any consolidation of data questionable.
Similarly, study “C” may confine comparisons to a finite universe of strategies, while study “D” adopts a macro view that encompasses hedge funds which ply an infinite variety of strategies. In both examples, attempts at comparing the conclusions are, by definition, flawed.
Taking the argument a step further, imagine that studies being compared were conducted in different years. Comparing a study concluded in 2009 to a study concluded in 2012 would necessarily yield disparate results due to the incongruity of market forces.
We know that we cannot predict how political climate will exert its influence on the direction of regulation and legislation and these forces will necessarily impact the performance of hedge funds regardless of size. Small hedge funds may be able to adapt more readily than large funds or, conversely, large funds may have superior resources allowing them to adapt in a manner that eludes smaller hedge funds. A recent example of one such change is lifting the general solicitation ban. Future changes may include redefining the parameters which constitute a qualified investor.
We do not know what innovative financial products are on the horizon and we certainly don’t know if they will be more or less suited to the small, medium or large hedge fund. We don’t know at this point what defines a small, medium or large hedge fund.
There Are also Unknown Unknowns
The significant factors affecting hedge fund performance may be unknown unknowns! How are potential investors supposed to govern themselves in this environment? While there is no clear-cut answer, the conclusions reached in existing studies trend in favor of the extremes. That is small hedge funds on one end and large hedge funds on the other, with those in the middle being the poorest performers.
Beyond the Question of Size
Factors other than size are key drivers in rates of return. Investors must look beyond size when choosing a hedge fund. Important factors include:
- The proven track record of the hedge fund manager
- The fund’s investment strategy
- Management and performance fees
The means of choosing a hedge fund hasn’t been distilled into anything resembling a scientific formula. Potential investors will continue to rely on their own good judgment, due diligence and gut instinct for the foreseeable future.