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Small or Young?

Updated: Jan 13, 2020

Emerging managers are an important part of the hedge fund landscape, with investors drawn by their potential to offer higher returns among other reasons.

However, the definition of an emerging manager will vary from investor to investor; a large new pension fund will consider as an emerging fund may differ from a small family office that exist for several years. One of the many ways to group or define emerging hedge funds to assess whether these funds do outperform their established counterparts is to use the following criteria:

· First-time funds (FTFs) with assets under management (AUM) of $300mn or less; which is called small ones;

· First-time funds with a track record of three years or less, which is called Young ones

Emerging hedge funds may be more apt to be considered vulnerable to capital losses. Psychologically, investors expect emerging manager hedge funds to generate strong returns in order to compensate for the higher risk that can be associated with investing in them. Funds with a track record of three years or less, and funds with $300mn or less in AUM, outperform the wider hedge fund industry over a 12-month, three-year and five-year timeframe (Fig. 1). Funds that have a track record of three years or less produce significantly better returns than both funds with $300mn or less in AUM (but older), and the wider hedge fund industry, delivering a five-year annualized return of 12.22% compared to 8.98% for small but older first-time funds.

Funds with a track record of three years or less show similar volatility to the wider hedge fund industry over a three-year basis. This indicates that investors, on average, may be rewarded with higher returns without necessarily higher volatility when investing in first-time funds with a shorter track record, compared with those with longer history.

This result complies with another analysis that saying the best performance of any hedge funds usually happens in the first five years from its inception. This phenomenon also indicates that the longer a fund stay unchanged the more chance they become less dynamic and aggressive. Therefore as an emerging manager, no matter how small or young, you need to come out from the comfortable zone as soon as possible. The three to five years is the time to complete this section.

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