First two years best for hedge funds

Hedge funds perform best in their first two years and tend to produce lower but more consistent returns as they get bigger, a new study has found.

The research by Pertrac Financial Solutions, a software provider, found hedge funds less than two years old produced average returns of 17.5 per cent a year, against 11.84 per cent for those more than four years old, and also had lower volatility.

Smaller funds also produced higher returns during the 10 years studied from 1996 to July last year, but were riskier, with highervolatility than large funds.

The industry is likely to examine the findings closely as an increasing number of investors are focusing on new managers in an attempt to secure higher returns. Hedge funds on average have seen their returns fall in recent years as the industry expands.

Meredith Jones, Pertrac managing director, said older, larger funds tended to have grown with the help of institutional investors and so had to offer the steady returns they wanted rather than chasing high returns and accepting the risk wealthy individuals are ready to take.

"The institutions are looking for a certain type of return and risk profile," she said. "In attracting that money the managers tend to move towards that profile."

Large institutions are increasingly backing up-and-coming managers, setting aside parts of their hedge fund investments with which they are ready to take more risk.

The US's biggest public pension fund, the California Public Employees' Retirement System, has set upa special emerging manager fund.