Institutional investors open to investing in smaller hedge funds, even if they still mainly invest in large ones

Preqin, a research provider, has interviewed around 300 hedge fund managers and looked into its fund size benchmark to gauge the effect of fund size on the overall industry.

To start with, institutional investors, even if most are open to investing in small and medium-sized hedge funds, tend to allocate to large hedge funds anyway. 66% of capital in the industry today (estimated at a total of $3.1tln) is sourced from institutional investors, and 82% of that capital is in funds that have at least $1bn in assets under management (AuM). Of these investors, only 11% will exclusively invest in large funds; 22% will consider investing in funds with less than $100m; and 52% have a minimum requirement that lies between $101m and $499m.

Currently, 7% of institutional investors invest in medium sized funds ($500-999m), 9% in small funds ($100-499m) and 2% in emerging funds (less than $100m). Private wealth organizations or institutions that have larger or more sophisticated hedge fund portfolios are most likely to invest in smaller funds, Preqin adds.

When looking at returns on a risk-adjusted basis, large funds have produced the highest three-year annualized return (as of 30 June 2015) with the lowest volatility. Emerging funds with less than $100m in AUM, in contrast, have produced the lowest three-year annualized returns with the highest level of volatility. Small and medium funds have the best returns, with small funds coming on top (10.05%), with a comparable level of volatility to medium funds.

Larger funds have an average track record of 12 years; they performed well in their early years, and were rewarded with capital commitments. "Therefore," Preqin says, "in the larger fund groups there has been selection for the better performing funds on an absolute and risk-adjusted basis, a reason why this group as a whole performs bett......................

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This article was published in Opalesque's New Managers a top-down monthly analysis, news and research publication on the global emerging manager space.