Survival, Look-Ahead Bias and the Persistence in Hedge Fund Performance

Hedge funds databases are typicall subject to high attrition rates because of fund termination and self-selection.Even when all funds are included up to their last available return, one cannot prevent that ex post conditioning biases affect standard estimates of performance persistence.In this paper we analyze the persistence in the performance of U.S. hedge funds taking into account look-ahead bias (multi-period sampling bias).To do so, we model attrition of hedge funds and analyze how it depends upon historical performance.Next, we use a weighting procedure that eliminates look-ahead bias in measures for performance persistence.The results show that the impact of look-ahead bias is quitesevere, even though positive and negative survivalrelated biases are sometimes suggested to cancel out.At horizons of one and four quarters, we find clear evidence of positive persistence in hedge fund returns, also after correcting for investment style.At the two-year horizon, past winning funds tend to perform poorly in the future.hedging;performance measurement;investment trusts

Survival, Look-Ahead Bias and the Persistence in Hedge Fund Performance

Hedge funds databases are typically subject to high attrition ratesbecause of fund termination and self-selection. Even when all fundsare included up to their last available return, one cannot preventthat ex post conditioning biases a.ect standard estimates ofperformance persistence. In this paper we analyze the persistence inthe performance of U.S. hedge funds taking into account look-aheadbias (multi-period sampling bias). To do so, we model attrition ofhedge funds and analyze how it depends upon historical performance.Next, we use a weighting procedure that eliminates look-ahead bias inmeasures for performance persistence. The results show that the impactof look-ahead bias is quite severe, even though positive and negativesurvival-related biases are sometimes suggested to cancel out. Athorizons of one and four quarters, we find clear evidence of positivepersistence in hedge fund returns, also after correcting forinvestment style. At the two-year horizon, past winning funds tend toperform poorly in the future.survival;performance measurement;investments;individual profiles;hedge funds

Bayesian inference for hedge funds with stable distribution of returns

Recently, a body of academic literature has focused on the area of stable distributions and their application potential for improving our understanding of the risk of hedge funds. At the same time, research has sprung up that applies standard Bayesian methods to hedge fund evaluation. Little or no academic attention has been paid to the combination of these two topics. In this paper, we consider Bayesian inference for alpha-stable distributions with particular regard to hedge fund performance and risk assessment. After constructing Bayesian estimators for alpha-stable distributions in the context of an ARMA-GARCH time series model with stable innovations, we compare our risk evaluation and prediction results to the predictions of several competing conditional and unconditional models that are estimated in both the frequentist and Bayesian setting. We find that the conditional Bayesian model with stable innovations has superior risk prediction capabilities compared with other approaches and, in particular, produced better risk forecasts of the abnormally large losses that some hedge funds sustained in the months of September and October 2008. --

Quantitative selection of hedge funds using data envelopment analysis

Previous studies have documented that Data Envelopment Analysis(DEA) could be a good tool to evaluate fund performance,especially the performance of hedge funds as it can incorporatemultiple risk-return attributes characterizing hedge fund's nonnormal return distribution in an unique performance score. Thepurpose of this paper is to extend the use of DEA to the contextof hedge fund selection when investors must face multi-dimensionalconstraints, each one associated to a relative importance level.Unlike previous studies which used DEA in an empirical framework,this research puts emphasis on methodological issues. I showedthat DEA can be a good tailor-made decision-making tool to assistinvestors in selecting funds that correspond the most to theirfinancial, risk-aversion, diversification and investment horizonconstraints.hedge funds, data envelopment analysis, fund selection, performance measurement, alternative investment

Do Hot Hands Exist Among Hedge Fund Managers? An Empirical Evaluation

We examine whether hot hands exist among hedge fund managers. In measuring performance persistence, we use hedge fund style benchmarks. This allows us to identify managers with valuable skills, and also to control for option-like features inherent in returns from hedge fund strategies. We take into account the possibility that reported asset values may be based on stale prices. We develop a statistical model that relates a hedge fund’s performance to its decision to liquidate or close in order to infer the performance of a hedge fund that left the database. While we find significant performance persistence among superior funds we find little evidence of persistence among inferior funds.

The performance evaluation of hedge funds: a comparison of different approaches using European data

The standard approach to the evaluation of funds assumes a normal return distribution and uses the variance as a measure of the funds risk. A few characteristics of hedge funds, such as the remuneration mechanism of the portfolio manager, make this assumption unacceptable and the traditional approach of Risk Adjusted Performance (RAP) must be revised before applying it to hedge funds. Some authors define a number of different RAP measures that attempt to overcome the problem related to the lack of normality: new RAPs are characterized by a more detailed return distribution analysis that does not consider only the first two moments of the distribution. A higher computational complexity may only be reasonable if selections founded on new RAPs permit to identify better investment opportunities than those selected with standard RAPs. This work analyses different approaches proposed with a view to calculating the RAP for hedge funds and evaluates advantages and limits of each proposed measure. An application of these measures to the European hedge funds market is proposed in order to demonstrate the usefulness of new approaches. An empirical analysis studies differences in funds classification based on different measures and demonstrates that the standard RAP approach is unable to identify the best performing hedge funds.Hedge funds; Risk Adjusted Performance and performance persistence

Evaluating hedge fund performance: a stochastic dominance approach

We introduce a general and flexible framework for hedge fund performance evaluation and asset allocation: stochastic dominance (SD) theory. Our approach utilizes statistical tests for stochastic dominance to compare the returns of hedge funds. We form hedge fund portfolios by using SD criteria and examine the out-of-sample performance of these hedge fund portfolios. Compared to performance of portfolios of randomly selected hedge funds and mean-variance e¢ cient hedge funds, our results show that fund selection method based on SD criteria greatly improves the performance of hedge fund portfolio

Do Hedge Funds Manipulate Stock Prices?

We find evidence of significant price manipulation at the stock level by hedge funds on critical reporting dates. Stocks in the top quartile by hedge fund holdings exhibit abnormal returns of 30 basis points in the last day of the month and a reversal of 25 basis points in the following day. Using intraday data, we show that a significant part of the return is earned during the last minutes of the last day of the month, at an increasing rate towards the closing bell. This evidence is consistent with hedge funds’ incentive to inflate their monthly performance by buying stocks that they hold in their portfolios. Higher manipulations occur with funds that have higher incentives to improve their ranking relative to their peers and a lower cost of doing so.

The value-added of investable hedge fund indices

This paper empirically investigates the risk and performance of three types of alternative beta products over the January 2002 to September 2009 time period: funds of hedge funds (FHFs), investable hedge fund indices (IHFIs), and hedge fund replication strategies (HFRS). We show that IHFIs are true alternative beta products with high correlations and beta to noninvestable hedge fund indices. Our results further suggest that, in a best case scenario, IHFIs outperform FHFs and HFRS on a risk-adjusted basis. However, in the worst case scenario, IHFIs underperform both investments. If we take the average of all IHFIs, we find they perform equally well as FHFs. Hence, IHFIs constitute a solid alternative to FHF investments, while costing substantially less, and offering generally more transparency and liquidity. We propose that fee-sensitive investors especially should consider taking a core-satellite approach to their hedge fund portfolio, with the core represented by cheap passive hedge fund beta through IHFIs, and the satellite represented by more expensive and actively managed alphagenerating FHFs. --Hedge funds,investable hedge fund indices,alternative beta,funds of hedge funds,hedge fund replication,Omega ratio

Legal aspects of german hedge fund structures

Increasingly, alternative investments via hedge funds are gaining importance in Germany. Just recently, this subject was taken up in the legal literature, too; this resulted in a higher product transparency. However, German investment law and, particularly, the special division "hedge funds" is still a field dominated by practitioners. First, the present situation shall be outlined. In addition, a description of the current development is given, in which the practical knowledge of the author is included. Finally, the hedge fund regulation intended by the legislator at the beginning of the year 2004 is legally evaluated against this background