Hedge-Fund Returns Dragged Down by ‘Hidden Bias’

Date: Wednesday, March 31, 2010
Author: Bloomberg

Hedge-fund returns are worse than industry figures would suggest because many funds on the brink of failure stop reporting on their performance, according to a new academic study.

These omissions create a “hidden survivorship bias” because funds in their last 12 months of existence are left out of the data, the study found. The gap in returns between these failing funds and others averaged 0.54 percent a month, or about 6 percent annually, for 1994 through the first quarter of 2009.

The CHART OF THE DAY shows the average monthly percentage differential for each full year studied as a white bar. There is also a blue line, depicting a similar return gap between failed funds as of March 2009 and survivors. The average for the latter was just 0.26 percent a month.

Both gauges were relatively low in 2008 as a credit crisis sent stocks and bonds plunging and weighed on returns across the industry, according to Seton Hall University Professor Xiaoqing Eleanor Xu and her co-authors on the study, TIAA-CREF’s Jiong Liu and Seton Hall’s Anthony L. Loviscek.

They found that 31 percent of all funds failed that year, more than double the annual average of 12 percent for the study period. There were 1,089 that collapsed, according to a database compiled by the University of Massachusetts Amherst and used in the research. Failures among funds of hedge funds and commodity trading advisers brought the total to 1,983.

Hedge funds should “be subjected to standard reporting procedures, including random audits,” to increase the accuracy of data on their performance, the authors concluded. Their study was posted March 17 on the Social Science Research Network and cited yesterday on Seeking Alpha, a financial blog.