CHAPTER 5 Does Size Matter? To what extent does a hedge fund’s growth and size affect its prospects for maximum performance, and how does this affect its investors? Investors need to model their investment portfolio to ensure proper diversification among strategies | 5 Does Size Matter To what extent does a hedge fund s growth and size affect its prospects for maximum performance and how does this affect its investors Investors need to model their investment portfolio to ensure proper diversification among strategies yet the findings of a recent study show that investors also need to evaluate funds of all sizes when making hedge fund allocations. Although the tendency may be for investors to believe that bigger is better and to invest with the large high-profile funds that is not always the right move. The study s implication is that small funds tend to outperform larger funds and that medium-size funds typically fare the worst. Therefore manager selection should be biased toward those hedge funds that are nimble and responsive and that generate alpha. Smaller funds can put all of their money into their best ideas larger more senior funds often find it difficult to put continued inflows to work due to the constraints of internal asset allocation guidelines and policies. The number of hedge fund managers is up from approximately 1 000 in the late 1990s to more than 6 000 in 2003 which makes it increasingly important to rely on rigorous due diligence when selecting the best-performing managers within the various investment styles and strategies. Although the number of managers has grown overall the ratio of hedge fund start-ups to closings within the hedge fund industry generates concerns over basic issues related to back-office operations transparency capacity and style drift many of which have been discussed in 65 66 HEDGES ON HEDGE FUNDS Size bucket US m 1999 2000 2001 FIGURE Size Distribution of Hedge Hunds. Source Van Hedge Fund Advisors. previous chapters. While approximately 700 to 800 hedge funds closed in 2002 another 800 to 900 new firms began operations. The question regarding the link between portfolio size and diminishing returns evolved from observations of top hedge fund managers in large funds such as Tiger .
