Investors who are attracted to large hedge funds because of their supposed safety and liquidity advantages may want to consider research results contained in a proprietary white paper released Thursday by Spring Mountain Capital as part of their due diligence before investing.
The paper, “The Relation Between Hedge Fund Size and Risk,” discusses the declining benefits of hedge fund size.It was written by Haim Mozes, a senior consultant with Spring Mountain who also teaches accounting at Fordham University, and Jason Orchard, a principal at the firm.
In their paper, Mozes and Orchard identify several factors that increase a large fund's risk profile relative to its smaller peers, according to a statement by Spring Mountain. They find that managers of large hedge funds are confident they will maintain good performance, thereby warding off investor redemptions, but "eventually, fund size will hinder performance enough to trigger a redemption cycle that has a strong negative feedback loop."
The authors find that although large funds may be seen as less risky than their smaller counterparts, research and experience says otherwise. Indeed, "in the future, the opportunity costs of investing in large funds may be higher and the safety benefit of investing in large funds may be lower than investors currently expect," Orchard said in the statement. "Today, there remain economic, policy and investment uncertainties that are likely to require managers to be nimble and adjust exposures quickly. Size could be a significant deterrent if this environment continues or were to worsen."