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Hedge funds: Alpha decays with age

Research points to declining returns and greater risk as hedge funds grow older

Mark Chambers: The risk
is in the early years

A research report to be published this autumn will no doubt become marketing fodder for start-up hedge funds. "Do emerging hedge fund managers present an investment opportunity?" is a study by London Business School MBA student Ranjit Sikka. Sponsored by UK financial services group Schneider, Sikka investigated the returns and risk levels of more than 1,100 European hedge funds over a 13-year period. The report concludes that young hedge funds consistently outperformed their mature counterparts, and that alpha decayed with age. Comparing a start-up portfolio with a portfolio of managers five years or older, the analysis shows that there is a decline in performance equivalent to 100 basis points per month, or about 12% a year.

That new hedge fund managers produce higher returns than their longer-running peers is not so surprising. Most hedge fund managers freely admit to being hungrier in the initial stages, and aware that an impressive track record needs to be built if they are to have any success in attracting capital.