This is an article that was published in the NYT:
When All Numbers Are In, Do Hedge Funds Shine?
Original Source: New York Times
Hedge funds use many strategies to try to produce extraordinary
returns in any market. But a new study suggests that, on average,
hedge funds may perform worse than mutual funds.
Download the full PDF study:
Reality Check On Hedge Funds
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download it here.
Previous studies have overstated average hedge fund returns because of
several deficiencies in hedge fund performance databases. Until now,
researchers have not had access to information that would let them
determine the extent of the bias.
Pieter Jelle van der Sluis, an assistant professor of finance at the
Free University of Amsterdam, and Nolke Posthuma, vice president for
research at ABP Investments, based in the Netherlands, recently found
the necessary data. They reported their findings in ''A Reality Check
on Hedge Fund Returns,'' a working paper that has been circulating
since July in academic circles.
Both hedge funds and mutual funds pool investors' money into single
managed portfolios. Unlike mutual funds, however, hedge funds are
generally unregulated and require high minimum investments.
According to the authors of the new study, databases for hedge fund
performance are misleading because participation in them is voluntary.
Each hedge fund decides whether to provide its performance data.
Because young hedge funds have too little data to interest those
databases' customers, the managers of these new funds often wait
several years before starting to report their track records. If their
records over those initial years turn out to be poor, they may choose
not to report at all.
That wouldn't necessarily create a bias, however, if the databases
recorded a hedge fund's returns only after it began reporting
performance. But at major databases, that has not been the case. When
adding a hedge fund, they also include its historical returns. Because
that process, known as backfilling, excludes the poor returns of funds
that choose not to report, it paints an overly optimistic portrait of
the average hedge fund's performance.
The researchers measured the magnitude of this so called backfill bias
by using the TASS database of Tremont Capital Management; the
researchers say that this database includes the greatest number of
hedge funds from around the world.
Once backfilled returns were eliminated, they found, the average
annual return of hedge funds from 1996 through 2002 dropped to 6.4
percent from 10.7 percent. But even the 6.4 percent figure is upwardly
biased, the researchers said, because hedge funds typically do not
report their returns over the last few months before they go out of
business, during which their returns may be dismal. For example, the
record of Long Term Capital Management in the TASS database ends in
October 1997, nearly a year before its collapse.
The researchers were unable to measure the magnitude of this second
type of bias. Professor van der Sluis and Mr. Posthuma came up with an
estimate, however, by assuming that the net asset value of a fund that
is closing shop declines 50 percent in the month it stops reporting to
the databases. On that assumption, average hedge fund returns from
1996 through 2002 dropped to almost nothing - just 0.1 percent a year,
annualized.
That is far worse than the performance of the average mutual fund.
According to Lipper Inc., the average annual return of a domestic
equity fund over that period was 4.9 percent; for domestic bond funds,
it was 6.1 percent.
LOWER returns for hedge funds could be justified if their volatility
were much lower than that of the average mutual fund In fact,
hedge-fund volatility should be quite low, because few of these funds
bet all or nothing on the direction of any market.
Using data from Professor van der Sluis and Mr. Posthuma, I calculated
the average monthly volatility of hedge funds to be about one-third
that of the Wilshire 5000. Still, no amount of reduced volatility
could make an annual return of 0.1 percent attractive.
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Another good resource is the http://www.hedgeindex.com/index.cfm?indice=90
site, it contains the data of numerous funds and compares their
performance to the S&P500 and other indices. The available sata starts
in 1993 and is updated daily.
Hope that helps |
