Accentuating Too Much Positive?

Date: Wednesday, October 10, 2007
Author: Hedge Fund Daily

Hedge fund managers, in an effort to make their portfolios look like winners, may be massaging results by picking and choosing what to report, a new study said. The research, by Assistant Finance Professor Veronika Pool of Indiana University and Associate Finance Professor Nicolas Bollen of Vanderbilt University suggests that 10% of the information in the database used is “distorted.” The authors used a database from the University of Massachusetts that included monthly returns of more than 4,200 hedge funds of different strategies between 1994 and 2005. “Hedge fund managers purposefully avoid reporting losses by marking up the value of their portfolios,” which, if true, could negatively affect investors as they “underestimate the potential for losses in the future and may overestimate the ability of hedge fund managers.” Pool and Bollen noted in their study that “the number of small gains far exceeds the number of small losses,” and they discounted database biases or hedge fund risk factors as causes. “These results suggest that some managers distort returns when possible, e.g. when fund returns are at their discretion and when their reported returns are not closely monitored.” While they suggest there is a “purposeful avoidance of reporting losses,” the authors say a possible alternative explanation is that managers are “optimistic in their valuations of illiquid securities held in their portfolios.” They say that hedge fund managers “might simply be prone to overvalue their own securities, perhaps the same way that retail investors have been shown to be overconfident in their abilities to pick winners.”