A Suggestion for Remedying the Overstated Performance of Non-Investable Hedge Fund Indices

The biases that inflate the performance of hedge funds have been well documented in the financial literature.

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Survivorship bias, which results from the ex post exclusion of unsuccessful funds from databases, is clearly one of the greatest causes of grossly overstated performance. Considering the returns of surviving funds alone leads to a strong upward bias, according to recent studies (up to 442 basis points, as demonstrated by Malkiel and Saha [2005]). In the same vein, backfill bias or instant history bias, which occurs when the historical performance of a successful fund is suddenly and retroactively added (backfilled) into the database, also distorts the performance of the hedge fund industry (up to 435 basis points, as shown by Posthuma and van der Sluis [2004]). These biases are not negligible and tend primarily to inflate the returns posted by non-investable hedge fund indices; hence the recent development of investable hedge fund indices that can help investors mitigate the effects, which are never done away with entirely, of these biases.
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A Suggestion for Remedying the Overstated Performance of Non-Investable Hedge Fu...
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Type : Publication EDHEC
Date : le 21/10/2010
Extra information : For more information, please contact Joanne Finlay, EDHEC Research and Development Department [ joanne.finlay@edhec.edu ] The contents of this paper do not necessarily reflect the opinions of EDHEC Business School.
Research Cluster : Finance

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