Nicole Boyson, an assistant professor of finance at Purdue University’s Krannert School of Management, said the best hedge fund results come when managers shoulder more risk.
For example, Boyson’s research indicated that there was a 20% difference in returns (4% annually) between a 52-year-old manager and the average 47-year-old manager. Further, young managers who have been strong performers in the past outperform old managers who have been poor performers in the past by 9% per year.
Bryson said there are number of reasons for older managers’ risk hesitancy:
- Older managers don’t want to endanger their generous compensation. A hedge fund manager with a $115 million fund in 2001 earned about $4 million that year, compared to a mutual fund manager who earned about $400,000.
- Older managers are also more likely to have their own assets invested in their funds.
- Younger managers tend to “herd” less than their older counterparts and make the bold investment plays that harvest superior returns.
Also, if a fund fails, Boyson says there are seldom second acts for hedge fund managers. So those funds and managers that do survive tend to want to hold on to what they have and begin to shy away from taking on the types of risk that will generate superior returns.
Fund of Funds
If investors want to dip their toes into the hedge fund waters, Boyson recommends considering going with a fund-of-funds (FOF). The downside is that diversified investing in FOFs is very expensive, Boyson says. Not only does the investor pay the FOF manager a fee, but also the fees associated with the underlying funds in which the FOF manager invests.
Since hedge funds are organized as private partnerships and are not subject to US Security and Exchange Commission oversight, Boyson said hedge fund managers can be – and generally are – secretive about their trading strategies so as to avoid copycat traders.
This secrecy makes it difficult for a potential hedge fund investor to choose a fund, Boyson says, but diligence is important since the minimum hedge fund investment is usually about $500,000.
A copy of the study is at http://www.mgmt.purdue.edu/faculty/nboyson/low%20returns%20final.pdf .