” Hedge Funds: Risk and Returns ,” a paper published by Burton Malkiel and Atanu Saha, stated that hedge fund indices should not be considered accurate because of both survivorship and backfill bias (See Study Calls Reported Hedge Fund Returns into Question ).
Van Hedge Fund Indices, in a press release, contend that the authors were wrong in asserting that all hedge fund indices had these biases. Not surprisingly, it contended that its – and other – indices do not have these traits in them. The firm also contended that the study was wrong to only look at issues that can inflate hedge fund returns and not ones that can deflate them. The company pointed to managers not reporting good returns due to the secrecy prevalent in the business as an example of a practice not addressed in the study.
The news release also questioned Malkiel’s bias, as it stated he is associated with the mutual fund industry and is an advocate of passive, index-based investing.
Backfill bias, Malkiel and Saha asserted, occurs because hedge funds report performance on a voluntary basis. Managers quite often will retroactively report returns if they are positive, while often failing to do so if returns are negative. Looking at incidences of such practices, Malkiel and Saha found that backfilled returns were more than 5% higher annually than those that were not backfilled.
Survivorship bias also warps the actual performance of hedge fund investments, according to the authors. While most hedge fund databases reflect the returns of hedge funds currently in existence, most do not include hedge funds that have failed (the study also asserted that only a quarter of funds in existence in 1996 are still around today). It is common, the authors asserted, for funds that are failing to stop reporting their returns for the months before they go under so only funds who are currently enjoying a successful run are included in an index, biasing the results so as to not include the entire hedge fund universe.