Nick Motson and a colleague from City University London recently concluded that small hedge funds outperformed large hedge funds on average over the 20-year period 1995-2014.  The smallest hedge funds, based on assets under management, returned 0.75% per month or 9% annually, compared to 0.61% or 7.32% annually for the largest funds. Given that 90% of the assets managed by hedge funds are with firms managing over $1 billion, while firms with under $100 million account for only 5% of such assets, the findings may suggest the “trend of just investing in the largest hedge funds is probably flawed,” according to Motson.  The paper also notes that smaller funds performed better during periods of financial stress, such as the 2008-09 downturn when smaller funds lost an annualized average of 9.6% less than the largest funds.

Scott Schweighauser, president of the nearly $8 billion Aurora Investment Management, offers some insight based on the sources of revenue for hedge funds. Firms typically receive a management fee of about 2% of assets under management, plus an incentive fee of about 20% of a fund’s profits. Schwieghauser notes that smaller funds are “much more attuned to generating returns that capture that incentive fee” because “it is a larger component of their revenue stream” than it is for bigger funds. He observes: “as firms grow, the management fee becomes a much larger [portion] of the overall revenue stream,” thus changing incentives.

Larger firms may be more risk-averse, offering a less volatile approach to investing. Peter Borish, chief strategist at Quad Group and formerly of Tudor Investment, compares large funds to a supertanker that is not as “nimble” as smaller funds. “If I take a risk and I’m wrong, I may lose assets,” large fund managers may think, according to Borish. He also notes that such funds may prefer established “brands” because it is easier to justify losses on such bets than on lesser known endeavors.