Fund liquidation, self-selection and look-ahead bias in the hedge ...

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wide range of empirical biases hampers hedge fund databases. In this paper A we focus upon survival-related biases and disentangle look-ahead biases to self-selection of funds and due to fund termination. Self-selection due because funds voluntarily report their information to data vendors arises may decide to stop doing so. By extending existing methodology, we and persistence in hedge fund performance over the period 1994-2000, analyze into account the above biases. The results show that look-ahead biases taking due to liquidation and self-selection enforce each other and may lead overestimating expected returns by as much as 8% per year. Overall, to results are consistent with positive persistence in hedge fund returns at the Abstract horizons of two and four quarters. JEL-codes: G11, G23, G14
the last decade, the hedge fund industry has grown enormously. During funds differ from mutual funds and other investment vehicles by their Hedge of regulation 1 , with limited transparency and disclosure, and by their lack structure (see, e.g., Fung and Hsieh, 1997). For example, most internal funds try to achieve an absolute return target, irrespective of global hedge movements, while hedge fund managers typically have incentive- market contracts. Accordingly, hedge funds have a broad flexibility in the based of securities they hold and the type of positions they take. On the other type investors in hedge funds are often confronted with lockup periods and hand, notice periods. Such restrictions on withdrawals imply smaller redemption fluctuations, and give fund managers more freedom in setting up longterm cash or illiquid positions. non-standard features make hedge funds an interesting investment Their vehicle for investors with potential diversification benefits. A wide of academic papers examines hedge fund performance and its persistence. range 2 Both for the mutual fund industry (Sirri and Tufano, 1998) and the fund industry (Agarwal, Daniel and Naik, 2004, Baquero and Verbeek, hedge 2006), it is reported that money flows chase past performance. Berk Green (2004) present a theoretical model that explains that persistence and be competed away by investors rationally shifting their money in search can superior investments. In the hedge fund industry, however, the presence for liquidity restrictions that prevent investors to quickly shift their money of one fund to the other, may result in genuine (short-run) persistence from if investors allocate their money according to past performance (see even ter Horst and Verbeek, 2005). Baquero, this paper we analyze the persistence in hedge fund performance tak- In ingintoaccountanumberofpotentiallyimportantbiasesthatarepresentin funds databases (see Fung and Hsieh, 1997, or Ackermann, McEnally hedge Ravenscraft, 1999) or are induced by the employed methodology. Survivorship and bias (see, e.g. Brown et al., 1992, Brown, Goetzmann and Ibbot- 1 U.S. hedge funds are defined by their freedom from regularity controls of the Invest- Company Act of 1940. ment 2 e.g., Brown, Goetzmann and Ibbotson, 1999, Agarwal and Naik, 2000, Bares, See, and Gyger, 2003, Boyson and Cooper, 2004, Capocci and Hübner, 2004, Baquero, Gibson Horst and Verbeek, 2005, and Jagannathan, Malakhov and Novikov, 2006. ter 1 Introduction 1
Page 1: Fund liquidation, self-selection an
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Page 9 and 10: self-selected liquidated survivors
Page 11 and 12: mean std.dev min max Variable 0.59
Page 13 and 14: 0.220 0.227 emerging markets −0.1
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Page 21 and 22: is now equal to the ratio of the nu
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Page 29 and 30: two important reasons why funds may
Page 31 and 32: 0.608 0.340 emerging markets 0.025
Page 33 and 34: Fung, W. and D.A. Hsieh, 1997, Empi

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