Intelligent Hedge Fund Investing
Successfully Avoiding Pitfalls through Better Risk Evaluation
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CHAPTER 13

INTRODUCTION

BIBLIOGRAPHY

ERRATA AND OTHER MATERIAL

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A CRITICAL EXAMINATION OF HISTORICAL HEDGE FUND RETURNS
Nolke Posthuma and Pieter Jelle van der Sluis

INTRODUCTION

As discussed by others throughout this volume, though perhaps not in exactly these words, knowledge is power. Investors who understand the way hedge fund data is gathered have insight into the data’s biases and limitations. Better investment decisions are the inevitable result.

Posthuma and van der Sluis implement a new approach for cleaning hedge fund index data affected by the well-known backfill bias in hedge fund returns data. This bias exists because hedge fund managers choose if and when to have their funds’ returns added to common databases.

A combination of this self-selection and liquidation results in hedge fund index returns to appear better than they actually are. Posthuma and van der Sluis show using their methodology that backfill bias may be much greater than previously thought. They find that it is pervasive across hedge fund styles and time periods.

They then use their cleaned data to examine whether they can find persistent patterns in hedge fund returns. If abnormally high returns persist, that is support for the argument that hedge funds (at least some at any rate) do provide excess returns. They divide hedge funds into deciles and examine the decile migration probabilities in consecutive periods.

They find that a fund in the highest (lowest) decile in one month has the greatest chance of remaining in that decile the following month. Interestingly, and somewhat contradictorily, they find that the second most likely return decile for the top (bottom) decile funds in the following month is the lowest (highest) decile. When they assign funds to deciles according to their information ratios (to account for volatility), they obtain similar results.

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BIBLIOGRAPHY

  1. Ackermann, C., R. McEnally and D. Ravenscraft, 1999, “The Performance of Hedge Funds: Risk, Return, and Incentives” The Journal of Finance, 54, 833-874.
  2. Agarwal, V. and Naik, N.Y., 1999, "On Taking the "Alternative" Route: Risk, Rewards, Style and Performance Persistence of Hedge Funds", LBS working paper.
    http://www.GloriaMundi.org/picsresources/rb-vann1.pdf
  3. Agarwal, V. and Naik, N.Y., 2000, "Multi-Period Performance Persistence Analysis of Hedge Funds", Journal of Financial and Quantitative Analysis, 35(3).
    http://www.GloriaMundi.org/picsresources/rb-vann2.pdf
  4. Asness, C., J. Liew, and R. Krail, 2001, "Do Hedge Funds Hedge?," Journal of Portfolio Management, Fall, pp. 6?19.
  5. Baquero, G. and J. Ter Horst and M. Verbeek, 2002, "Survival, Look-Ahead Bias and the Performance of Hedge Funds," working paper, Erasmus University Rotterdam, Tilburg University.
    http://www.GloriaMundi.org/picsresources/rb-bv.pdf
  6. Brown, S. J., and W. Goetzmann, 2003, "Hedge Funds with Style", Journal of Portfolio Management, 29(2), pp. 101-112.
  7. Brown, S. J., W. N. Goetzmann, R. G. Ibbotson, and S. A. Ross, "Survivorship Bias in Performance Studies," Review of Financial Studies, 5, pp. 553–580.
  8. Brown, S.J., W.N. Goetzmann, and R.G. Ibbotson, 1999, "Offshore Hedge Funds: Survival and Performance 1989-95," Journal of Business 72(1), 91-117.
    http://www.GloriaMundi.org/picsresources/rb-bgi.pdf
  9. Brown, S. J., W. N. Goetzmann, and J. Park, 1998, "Conditions for Survival: Changing Risk and the Performance of Hedge Fund Managers and CTAs," working Paper, NBER, New York University and Yale School of Management, International Center for Finance.
    http://www.GloriaMundi.org/picsresources/rb-bgp.pdf
  10. Brown S. J., W. N. Goetzmann, and J. Park, 2001, "Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry," Journal of Finance, 56, pp. 1869-1886.
  11. Edwards, F. R. and M. O. Caglayan, 2001, "Hedge Fund Performance and Manager Skill," Journal of Futures Markets, 21(11), pp. 1003–28.
  12. Fama, E., and K. French, 1993, "Common Risk Factors in the Returns on Stocks and Bonds," Journal of Financial Economics, 33, PP. 3 – 56.
  13. Fung, W. and Hsieh, D. A., 2000, "Performance Characteristics of Hedge Funds and Commodity Funds," Journal of Financial and Quantitative Analysis, 35(3), pp. 291-307.
    http://www.GloriaMundi.org/picsresources/rb-fh1.pdf
  14. Fung, W., and Hsieh D., 2001, "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, 14 (June), 313-341.
    http://www.GloriaMundi.org/picsresources/rb-wfdh2.pdf
  15. Goetzmann, W. N. and J. E. Ingersoll and M. I. Spiegel and I. Welch, 2002, "Sharpening Sharpe Ratios," Yale ICF Working Paper No. 02-08.
    http://www.GloriaMundi.org/picsresources/rb-gisw.pdf
  16. Grinblatt, M. and S. Titman, 1989, "Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings," Journal of Business, 62, pp. 393–416.
  17. Kat, H. M. and F. Menexe, 2003, "Persistence in Hedge Fund Performance: The True Value of a Track Record," Journal of Alternative Investments, 5, pp. 66–72.
  18. Liang, B., 2000, "Hedge Funds: The Living and the Dead", Journal of Financial and Quantitative Analysis, 35, pp. 309-326.
    http://www.GloriaMundi.org/picsresources/rb-bl2.pdf
  19. Lo, A., 2001, "Risk Management for Hedge Funds: Introduction and Overview," Financial Analysts Journal 57, pp. 16–33.
    http://www.GloriaMundi.org/picsresources/rb-al.pdf
  20. Lo, A., 2002, "The Statistics of Sharpe Ratio," Financial Analyst Journal, 58(4), pp. 36-52.
  21. Malkiel, B, 1995, "Returns from Investing in Equity Mutual Funds," The Journal of Finance, 50(2), pp. 549-572.
  22. Okunev, J. and D. White, 2002, "Smooth Returns and Hedge Fund Risk Factors," working paper.
    http://www.GloriaMundi.org/picsresources/rb-ow.pdf
  23. Posthuma, N. and Van der Sluis, P. J., 2003, "A Reality Check on Hedge Fund Returns", Working Paper.
    http://www.GloriaMundi.org/picsresources/rb-pv.pdf

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ERRATA AND OTHER MATERIAL

  1. Related research:
    • Malkiel, B and Saha, A., 2004, "Hedge Funds: Risk and Return," Working Paper (December).
      download paper (1.38Mb)
    • Van, G. P., and Song, Z., 2004, "Historical Hedge Fund Returns Fairly Represent Performance," Working Paper (December).
      download paper (201Kb)
  2. Other research by Nolke Posthuma:
    SSRN website
  3. Other research by Pieter Jelle van der Sluis:
    SSRN website
  4. Homepage of Pieter Jelle van der Sluis:
    http://home.wanadoo.nl/ecvandersluis/pj/INDEX.HTM

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INSIDE REVIEWS PURCHASE

Introduction

Table of Contents

Contributors

"How exciting to read a book that is so timely and practical"
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Publisher: Risk Books
Hardcover: 470 pages
ISBN: 19044339220

Editor: Barry Schachter

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