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Large versus small hedge funds: does size affect performance ? Authors: Greg N. Gregoriou, Fabrice Rouah Source: Journal of Alternative Investment Date: Winter 2002 |
The authors examine the relationship between the size of hedge funds and their performance. This relationship has already been discussed in the mutual fund literature: some studies posit that an increase in size allows performance to be improved, whereas other studies posit an inverse relationship between size and performance.
The sample is composed of 204 hedge funds and 72 funds of hedge funds (because of their distinctive features, the funds of hedge funds are examined separately). The accuracy of the results is affected by survivorship bias (Fung and Hsieh infer that the survivorship bias is 3 % per year for hedge funds).
Three performance measures are used: the geometric mean return, the Sharpe ratio and the Treynor ratio. They are calculated from monthly data net of fees, from January 1994 to December 1999. The Sharpe and Treynor ratios have the advantage of being risk-adjusted measures. The Sharpe ratio supplies the net return to investors per unit of total risk. The Treynor ratio provides the risk premium per unit of total risk. The size of a fund is the total asset amount at the start of the calculation period. The relationship between size and performance is tested by the coefficients of Pearson correlation and the Spearman rank correlation.
The first result relates to the number and percentage of hedge funds and funds of hedge funds that outperform the S&P 500 and MSCI World Market Indexes. It appears that a higher proportion of hedge funds outperform the two indexes than their fund of hedge funds counterparts. This result is statistically significant whichever performance measure is used, according to the chi-square test of proportions. It is explained by the risk diversification inherent in funds of hedge funds, which invest in many hedge funds with different styles, but it is not adequate to conclude that there is an inverse linear relationship between size and performance.
The second result concerns the correlation between starting asset size and the performance of hedge funds and funds of hedge funds. Using the geometric mean, the Sharpe ratio and the Treynor ratio, the correlations are not statistically significant.
The authors conclude that the size of a hedge fund (and of a fund of hedge funds) has no impact on its performance. However, they suggest testing this relationship again over a longer period, because some size factors are liable to hurt the performance, for example the lower speed of operations due to administrative duties.
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