The Case For Growth Stage Investments
Life Cycle of an Investment Matters
Like all businesses, investments also have a development life cycle. We believe that investing during the growth stage of an investments life cycle can have benefits multiple benefits. To illustrate this point we examined hedge funds as a case in point.
Although established hedge fund managers with long track records, significant asset under management have attracted the majority of inflows into the hedge fund industry, our research shows that smaller or capacity controlled hedge funds have outperformed their larger rivals since 2000 on a risk-adjusted return basis.
The Link Between Size, Age and Performance
Our research has demonstrated that young funds deliver better returns on a consistent basis regardless of strategies and substantiates are view that not only is their a life cycle with portfolio managers, but that investors have a better alignment of interest with managers of smaller or capacity controlled funds.
In our view, larger and more established funds are hindered from an investment standpoint due to the following reasons:
They have a reduced ability to be nimble because of their size
Larger funds have a narrower investment universe due to a need to focus on the largest and most liquid opportunities
Furthermore, we believe that investors have a poor alignment of interest with larger funds for the following reasons:
Larger funds tend to be focused on asset gathering and management fee annuity, and as a result may focus on lower volatility of returns for stable earnings profile
Investors typically have limited access and transparency into the organization and investment portfolio
Our experience indicates that there is a better alignment of interests for investors with smaller or capacity controlled managers and investment opportunities earlier in their life cycle for the following reasons combined with the ability to generate higher risk-adjusted returns for the following reasons:
Investment teams are focused on performance fee versus management fee income
They have a greater ability to be nimble in the portfolio management process relative to larger funds
There is typically broader investment universe for smaller managers which enables them to focus on non-consensus, idiosyncratic and less traversed ideas
The ability to be nimble and a larger investment universe results in decreased correlation with other hedge fund strategies
Investors are likely to have better transparency and access relative to larger funds
Younger managers and investment teams with smaller size or those that focus on controlling investment size, regardless of strategies, tend to generate higher returns and alphas. This differential in our view can be explained by the ability of managers with a smaller asset base to be both nimble in the portfolio management process and be able to focus on idiosyncratic, less crowded ideas.
We believe that the link between size, age of an investment opportunity or fund, can have a direct link to performance despite asset class. As a result, contemplating the stage at which you invest in something, may be as important as what you invest in.