We find that medium sized funds went through
\nsimilar changes and broadly show median
\ncharacteristics between those from small and
\nlarge funds. They might be best fit for those
\nlooking for a balanced risk\/reward mix.<\/quote><\/p>\n
Should alternative portfolios favor smaller, medium, or larger hedge funds? The choice might not be as obvious as
\nbefore and may be more dependent on the stage of the business cycle. For many years, small hedge funds have
\nsteadily outperformed their large peers, sometimes by double digits in the 2000\u2019s. Since the financial crisis, returns
\nbetween these groups have leveled off, and they share the lead one after the other.<\/p>\n
Smaller funds\u2019 flexibility has been a key advantage as they are able to move capital faster. Their reduced impact on
\nmarket liquidity also allows them to access a wider spectrum of niche and specialized segments. More dependent on
\nvariable fees than on management fees, managers bear greater pressure on performance and tend to show more
\n\u2018animal spirit\u2019. Moreover, many talented traders within larger firms created their own smaller funds, boosting alpha
\ngeneration. In contrast, their higher relative fixed costs have become more impactful in recent years, only partially
\noffset by lower investors fees. Finally, smaller fund indices might overstate returns due to survival bias.<\/p>\n
The advantages of larger funds have started to be more impactful in recent years. Their larger asset base provides
\nthem with negotiating power on execution costs (brokerage and leverage fees in particular), while diluting their fixed
\ncosts (such as their administration fees, cost of access to information, research teams, etc.). In a world of lower growth
\nand lower rates, fees and costs have become key performance variables. Size of assets also matters positively in
\nareas such as activism, private equity, primary issuance markets, etc. Additionally, they may be better equipped and
\nstaffed to deal with rising regulation\/compliance and risk management costs. In a more challenging environment for
\nasset raising and alpha generation, larger funds may have now more arguments and means to attract and retain
\ntalents. Apart from the inertia typical of larger structures, their main constraints lie with tighter market access and
\ngreater liquidity impact (higher slippage cost, sliced trading execution), both costly for alpha. <\/p>\n
Relative advantages and constraints did converge, thus sustainably reducing the performance gap linked to <\/p>\n
size. Our
\nanalysis suggests that a growing share of the gap (about 2\/3) can be explained by the smaller funds\u2019 more aggressive
\nmarket risks, either through leverage or riskier sectors\/country\/instrument exposures. Their volatility, also structurally
\nhigher, is consistent with market exposures. In short, excess alpha generation from smaller funds shrunk, making their structurally higher beta exposure matter more. As a result, small funds tend to lead in early and
\nmid cycles but lag in late cycles and recessions.<\/p>\n
Small funds have underperformed since 2017,
\nin sync with rising uncertainties and decelerating
\neconomic growth. Exception to the rule: we find
\nthat the lag vs. large funds mostly stemmed from
\nweaker alpha. They regained some the lost
\nground in recent weeks, mostly due to their
\nrelative market risks this time.<\/p>\n
While the performance gap between small and
\nlarge funds shrunk in all regions, global and
\nEuropean small managers kept a slight alpha
\nedge relative to their U.S. and EM peers.<\/p>\n
We find that medium sized funds went through
\nsimilar changes and broadly show median
\ncharacteristics between those from small and
\nlarge funds. They might be best fit for those
\nlooking for a balanced risk\/reward mix.<\/quote><\/p>\n
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