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New hedge fund managers outperform vets
Size, as well as age, matter when it comes to beating out competitors, research firm finds.
July 5, 2005: 5:18 PM EDT
By Amanda Cantrell, CNN/Money staff writer

NEW YORK (CNN/Money) - Investors tip-toeing into the world of hedge funds often seek out managers with track records of at least three years, but this may be hurting their portfolios, according to a new study.

The study, from Chicago-based hedge fund tracker Hedge Fund Research, shows that "emerging" hedge fund managers, or managers who have been running money for less than two years, outperform more experienced managers.

Furthermore, the research shows, these new funds tend to do better than new funds run by more established managers.

One reason for this "rookie effect," as Hedge Fund Research dubbed the phenomenon, is young managers need to outperform their peers to get new investors, meaning they may be willing to take more risks than more established managers.

Funds in their first 12 months of operation produce the most significant out-performance.

In addition, smaller funds are more nimble, meaning they can dart in and out of trades and focus on their best investment ideas.

But funds in their first two years of operation are also more vulnerable to failure than older funds, according to the research. These funds have to establish a good track record to attract assets and at the same time run on limited resources.

It can also be difficult for new managers to learn the ropes of running a business and a portfolio at the same time. A former trader from an investment bank's research desk, for example, suddenly has to worry about meeting payroll, covering expenses and making tech resources work. Those issues, rather than their ability to manage money, can make new managers vulnerable, according to Hedge Fund Research.

Hedge fund investor Hunt Taylor, director of investments at Hartz Trading, the investment arm of the Hartz Group, said the idea that new managers outperform more established managers makes sense.

From a technical standpoint, as funds get larger, their transaction costs get higher.

But another factor is just common sense, Taylor said.

"When funds are just starting they don't have a critical mass of investors," he said. "Therefore if they do not make returns they don't get performance fees. Without performance fees they don't survive. A year and a half of flat returns out of the box and you're not in business."

Performance fees are levied on profits that a hedge fund generates during a given 12-month period, and usually come on top of asset management fees.

When funds get large enough, they can afford to coast at times, a condition known as "red Ferrari syndrome," when they preserve capital and collect fees, even without posting big returns, because their asset pool is so large. This can encourage some managers to play it safe, because they know they will make money anyway.

Emerging managers account for nearly 10 percent of total hedge fund assets under management, based on the firm's estimate that the industry manages a total of $1 trillion in assets. The managers surveyed run $74 million on average, the firm found.

The firm said its findings held true when looking at managers over three-, five- and 10-year time periods.  Top of page


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