Does Size Matter in the Hedge Fund Industry?

38 Pages Posted: 23 Jan 2009

See all articles by Melvyn Teo

Melvyn Teo

Singapore Management University - Lee Kong Chian School of Business

Date Written: January 22, 2009

Abstract

We document a negative and convex relationship between hedge fund size and future risk-adjusted returns. Small hedge funds outperform large hedge funds by 3.65 percent per year after adjusting for risk. This over performance is not driven by fund age, leverage, serial correlation, or self-selection biases. The capacity constraints manifest across various investment styles and regions. In particular, they are strongest for funds managed by multiple principals who trade small, illiquid securities, suggesting that the observed diseconomies can be traced to price impact and hierarchy costs (Stein, 2002). While investors direct disproportionately more capital to smaller funds, they do not do so quickly enough to eliminate this size effect. Interestingly, the capacity constraints facing individual hedge funds do not extend to funds of hedge funds.

Keywords: size, hedge funds, capacity constraints, hierarchy costs

JEL Classification: G12, G20

Suggested Citation

Teo, Melvyn, Does Size Matter in the Hedge Fund Industry? (January 22, 2009). Available at SSRN: https://ssrn.com/abstract=1331754 or http://dx.doi.org/10.2139/ssrn.1331754

Melvyn Teo (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore
+65 6828 0735 (Phone)
+65 6822 0777 (Fax)

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