Hedge funds: bigger vs. better

From Institutional Investor‘s Hedge Fund Daily:

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Why Bigger HFs Not Always Better

While investors flock to bigger and better established hedge funds because of the imagined sense of security, they may be taking risks of which they are unaware. In an interview with Thomson Investment Management News, Max Ferri, a senior analyst at Laven Partners, points out that because the big funds tend to attract more money, they are also more tempted to find lucrative ways of spending their cash load that may not be in line with their business plan.  “Some funds set themselves reasonable targets when they start off,” Ferri says.  “However, with growth also comes greed and when people start knocking at the door like crazy, funds can start to overexpand.”  He says funds that experience exponential growth may find their capacity point is 100 times more than when they started and at that new level, “the strategy can no longer be run without carrying some sort of major risk, or is simply too big to be profitable.”  That’s when such funds may suffer from style drift, and suddenly the fund becomes more correlated to the markets and less of a hedge fund.  Ferri, who is also in charge of hedge fund selection at Laven, says his firm sticks to early-stage managers, since “best returns are found within the first three years of a manager’s strategies,” while the assets are still manageable.  And he says the “sweet spot” in terms of HF size is between $50-$100 million and $300-$400 million.

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