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

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Zeckhauser (1997) and ter Horst, Nijman and Verbeek (2001) such a and could be explained by look-ahead bias. If we correct for look-ahead pattern the expected returns on the lower deciles are significantly reduced and bias J-shape flattens. As a result, the relationship between past and future the expected returns on a zero The portfolio that is long in winners (decile 10) and short in losers investment with a t-value of −3.11. At the bi-quarterly horizon, the winnerloser significant portfolio has an expected return of 11.9%, and the correction for look- bias has very little impact. Brown, Goetzmann and Ibbotson (1999), ahead and Naik (2000), and Bares, Gibson and Gyger (2003), also find Agarwal of a persistence pattern at a short term horizon, while the pattern evidence less strong at longer horizons. However, note that these studies do not is for look-ahead bias, and that without corrections, average returns correct be overestimated by as much as 7.7% (decile 1, annual horizon). For may discussion on correcting for look-ahead bias we refer to Baquero, additional Horst and Verbeek (2005). ter Subsequent period performance 0.2500 0.2000 0.1500 0.1000 0.0500 0.0000 1 2 3 4 5 6 7 8 9 10 Initial period rank raw returns corrected returns double corrected returns Figure 2: Four-quarterly persistence in raw returns. performance becomes more monotonic. 1), is approximately 10.0% at the annual horizon, while it is only 4.3% (decile no correction for look-ahead bias is applied. The difference is statistically if The most striking result is that the correction for look-ahead bias due to 22
works in the same direction as the one for liquidation bias, and self-selection strengthens the positive persistence patterns. For most of the deciles thus see that the two biases have the same sign. Apparently, the majority we funds that stop reporting voluntarily have lower returns than those that of to report, consistent with Tables 1and 4. Accordingly, there is no continue effect that reduces the liquidation bias due to relatively counterbalancing funds that close for new investments and stop reporting. Thus, successful Ackermann, McEnally and Ravenscraft (1999) argue that positive and while survival-related biases may offset each other, this does not apply to negative bias due to liquidation and self-selection. Because this conclusion look-ahead be related to the way we define liquidation and self-selection cases, the may section provides some robustness checks. next mentioned before, it is difficult to pin down what exactly self-selection As for hedge funds. For example, a fund may decide to stop reporting means it is too small and subsequently decide to liquidate several quarters because Our classification of attrition cases so far was determined by the later. information provided by TASS and, when necessary, by the sign qualitative the fund’s cash flows in the last available year. We have experimented of alternative classification procedures, resulting in qualitatively similar with when we analyze performance persistence. To be precise, the post- results expected returns for all deciles after correcting for both liquidation ranking self-selection bias are highly robust, although the individual magnitude and the two biases depends upon the exact classification scheme. The latter of can be attributed to the problem that it is not unambiguous whether finding given situation should be classified as self-selection or liquidation. a this section we report the results when we classify disappearance rea- In 2 (“at fund manager’s request”) and 4 (“unknown”) into positive and sons events by using additional information on fund flows and returns. negative particular, we classify a case as “liquidation” when a fund experiences In cash flows in its last year, has negative cumulative returns over the negative year and has negative returns for each of the last two quarters of its last period. All other cases are treated as “self-selection”. Because reporting 5 Robustness checks empirical studies report that flows are highly linked to past performance 23
Page 1 and 2: Fund liquidation, self-selection an
Page 3 and 4: the last decade, the hedge fund ind
Page 5 and 6: terHorst,andVerbeek(2005)findsthatl
Page 7 and 8: to not report returns and other inf
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
Page 15 and 16: 2005). both specifications, age has
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Page 19 and 20: performance decile), it is most con
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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