Content area
Full Text
A large number of different hedge fund strategies has been developed over time, and the number of hedge funds is increasing at record rates. Approximately 15,250 single manager hedge funds including approximately 2,050 CTAs and 7,400 funds of hedge funds were counted in the 2007 hedge fund database study of PerTrac Financial Solutions.1 The numbers show an increase of 1,575 single manager hedge funds and 1,300 funds of hedge funds from the 2006 hedge fund database study. Although it remains difficult to quantify the actual size of the hedge fund industry due to the lack of regulation, the asset base in single manager hedge funds is estimated to be around USD 2.1 trillion in 2007,2 an impressive growth compared to USD 400 billion in 1995.3 Projected growth rates for the coming years remain high as institutional investors intend to increase their allocation to hedge funds. Many large hedge funds are already closed for new investments due to limited capacities in their strategies. Hedge fund investors conjecture that further asset flows into the hedge fund industry go hand in hand with decreasing performance due to limited investment opportunities for various hedge fund strategies.
Many studies have been published about factors impacting hedge fund returns, such as Fung and Hsieh [1997], Agarwal and Naik [2000], Schneeweis, Kazemi, and Martin [2003], Ammann and Moerth [2005], and Brealy and Kaplanis [2003]. This study focuses on two factors, fund sizes and fund flows.
The impact of fund sizes on hedge fund performance is non-trivial. Large funds tend to have a diversified client base, more resources, and often a more rigorous risk management approach compared to smaller funds. Smaller funds need to attract assets and prove themselves. Therefore they may be willing to take on more risk and have higher expected gross returns. In order to assess expected net returns, operational costs need to be taken into account. In that respect smaller funds are at a disadvantage due to a higher cost ratio based on relatively high fixed operating costs.
The relationship between fund sizes, fund flows, and performance is evaluated from different angles. Returns, standard deviations, Sharpe ratios, and alphas derived from an asset class multi-factor model are investigated with respect to fund sizes and fund flows. The study...