| Limits of hedge fund indices |
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| 11/11/2007 | |
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Hedge fund indices have shown divergent results in recent years. Even those competing in the same strategy have displayed different returns. The lack of homogeneity in hedge fund index returns suggests investors are unable to get a true view of hedge fund performance, yet this reality is hardly specific to the world of hedge funds. A number of equity indices display a similar lack of homogeneity, according to Edhec. One of the reasons for the wide variance is that none of the existing indices is fully representative: a number of funds that should be part of an index are not included in it. "Because of the lack of regulation of hedge fund disclosure, existing databases cover only a relatively small fraction of the hedge fund population," notes the Edhec report authored by Nöel Amenc and Felix Goltz. "It is likely that only slightly more than half of the existing hedge funds choose to self-report their performance to one of the hedge fund databases." Survivorship bias Since a fund's participation in a database is voluntary, some remain unobservable. They may refuse to post performance data because of poor results; others because they have already reached critical mass. It is difficult to measure whether this has a positive or negative impact on the performance results. In addition, depending on the date at which the database started, the quality of historical data will vary. "This is known as survivorship bias. Since the HFR and CISDM databases began in 1994, it is likely that they will dispose of more accurate information than the CSFB database (which only began in 2000) over the 1994-2000 period. Brown, Goetzmann and Ibbotson valued the average impact of this bias at 2.6% compared to 3% for Fund and Hsich and 2.73% for Liang." Here are some the report's findings: of the 1,162 HFR funds and the 1,627 TASS funds, only 465 are common to both databases. Considering the 465 funds, only 154 were included in the two databases at the same time. As a result, the average performances displayed by the funds during their incubation period will be better than those of funds that have belonged for a longer period to the database under consideration, resulting in history or "backfill" bias which Fund and Hsieh measured at 1.4% per year. Equity style indices are not immune from the problems of return homogeneity, according to Amenc and Goltz. In order to assess the representativeness of hedge fund indices with respect to that of stock market indices, Edhec compared the heterogeneity of hedge fund indices to that of equity indices. The results demonstrate that equity indices in the categories of growth and value, for instance, showed wider variation than the performance of hedge fund strategy indices. "For example, looking at the February 2001 returns of value stocks, an investor using the S&P index would have observed a return of -11.1% while an investor using the FTSE index would have observed a return of -3.3%, a difference of 7.8% in terms of monthly return. Even equity-style indices which seem to be well established as underlyings for indexing products show a low degree of representativeness." VB |
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