Large Hedge Funds Have Outperformed Smaller Hedge Funds in 2008

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AlternativeSoft, a software company focusing on measuring hedge funds and fund of funds extreme risks, found that during the 2008 crash (i.e. from July to December 2008), large and medium hedge funds outperform their smaller peers in terms of returns; also large hedge funds outperform smaller hedge funds in term of Sharpe ratio.

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Large hedge funds have outperformed smaller hedge funds in 2008, according to AlternativeSoft.

INTRODUCTION
2008 will be remembered as the year that transformed the financial sector, the traditional side of the industry lost many of its key players; size did not matter, numerous companies whether they were big or small were bought to their knees. In this article, an analysis of the hedge fund 2008 returns is performed, in particular the influence of hedge fund size and strategy on the fund performance. This analysis utilises the AlternativeSoft software platform to run statistics on individual funds, as well as on a group of hedge funds. In order to keep this article readable, no statistical measures like R2 or t-statistics are used, but only returns and volatilities.

The hedge fund universe is divided into four groups of different asset under management (AUM) sizes:

                     AUM range    Average
                     (USD m)        AUM             Number of funds
Small             10-100         35.13            2'279
Medium         101-500        235.38         760
Large            500+             700.31         202
Super Large    10 largest     6'559            10
Source: AlternativeSoft, hedgefund.net database

During the 2008 crash (i.e. from July to December 2008), large and medium hedge funds outperformed their smaller peers in terms of returns. Also large hedge funds outperform smaller hedge funds in term of Sharpe ratio.

PERFORMANCE ANALYSIS
In this first section, hedge fund performance will be investigated. During 2008, the Super Large hedge funds outperform the other funds on average by 12.43%. To put this into perspective, analysing returns over 2008 for each individual group, it becomes apparent that the Super Large hedge funds (-0.35% in 2008) on average outperforms Large (-7.75% in 2008), Medium (-9.26% in 2008) and Small (-14.43% in 2008). These results provide evidence that the Super Large hedge funds performed better than its smaller peers in 2008. However in order to really check whether these returns were due to smart investment decisions or to excess risk, the Sharpe Ratio will be considered. Calculating the average Sharpe ratio in each group, the following results are obtained:

                     Sharpe Ratio
Small             0.67
Medium         0.99
Large            1.09
Super Large 1.23
Source: AlternativeSoft, hedgefund.net database, 2% risk free rate, Jan08-Dec08.

From above, it becomes clear that the risk-adjusted performance of larger funds is better than that of smaller funds. Thus in 2008 the performances of Super Large hedge funds relative to its smaller peers were better in terms of both returns and Sharpe ratio.

STRATEGY ANALYSIS
In this second section, having already analysed the effects of size, the relationship between hedge fund strategy, size and 2008 returns is investigated. To simplify the analysis the four most popular strategies only are examined:

  • CTA
  • Equity Long-Short
  • Macro
  • Multi-Strategy

The year will be looked at in two parts: January to December 2008 and July to December 2008. This will provide a rational approach to comparing and contrasting between the performance during the entire year and the performance during the financial crash at the end of 2008. The table below shows the results. The Super Large group is not included as there are not enough funds per strategy to provide meaningful results.

                     Average
                     AUM             Jul-Dec08     Jan-Dec08    Sharpe Ratio
CTA             (USD m)            
Small             31.54            4.03%    19.58%    0.68
Medium         243.07         7.15%    21.73%    0.81
Large            732.86         7.06%    21.69%    1.00

Equity Long-Short                
Small             34.22    -17.74%    -19.81%    0.32
Medium         227.41    -14.77%    -15.75%    0.70
Large            693.33    -15.22%    -13.27%    0.79

Macro                
Small             32.78    -6.05%    -2.89%    0.48
Medium         266.44    -8.04%    -4.56%    0.83
Large            736.00    4.74%    15.14%    1.36

Multi-Strategy                
Small            36.43    -16.16%    -15.85%    0.56
Medium        232.80    -14.90%    -13.74%    0.51
Large         653.81    -17.17%    -15.15%    0.98
Source: AlternativeSoft, hedgefund.net database, 2% risk free rate.

From July to December 2008, in CTA, Equity Long-Short and Multi-Strategy, the medium sized hedge funds performed the best; however for each of them the large sized funds had the best Sharpe Ratio. This indicates that the medium sized hedge funds were exposing themselves to slightly more risk (assuming risk is defined with volatility only). In Macro, the large funds had higher returns and larger Sharpe ratio than smaller funds.

CONCLUSION
In this paper, the performance of hedge funds in 2008 was investigated. The analysis found that the larger funds performed better than its smaller peers. The main reason why this occurred is because larger funds were able to better manage risk than smaller funds. This was shown by the fact that the Sharpe ratios for the larger funds were higher than the smaller funds. In addition, the larger funds had more experience as shown below with a longer track record history. So experience matters when crash comes.

                     Average Track Record
Small             66 months
Medium         78 months
Large            91 months
Super Large 139 months

A basic strategy investing in the 10 Super Large hedge funds mixed with large hedge funds (>USD500m), would have easily outperformed the hedge fund indices and other smaller hedge funds, in term of returns and Sharpe ratio during 2008.

AlternativeSoft, Zurich
http://www.alternativesoft.com

REMARKS
Funds with assets <USD10 millions were not considered. Funds of Hedge Funds were not included in the study. December 2008 data were not available for all funds. In the 'Super-large group, two hedge funds had large returns, which may skew the results. We intentionally do not use statistical measures like R-squared, t-statistics or Granger causality in order to keep the paper readable.

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Ravi Malhotra
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