Hedge funds are attracting a glut of new money because hedge fund indexes hugely overestimate the industry's performance, a leading U.S. academic said, according to Reuters.
Burton Malkiel, famed economics professor at Princeton University and author of A Random Walk Down Wall Street, said that while hedge fund assets have swelled to about $1 trillion between 1998 and 2004, investors should be wary of how fund performance is measured.
Speaking at the 2005 Institutional Fund Management conference in Geneva this week, Malkiel punched holes in the prevailing notion that hedge funds have posted superior gains. He pointed out that the loosely regulated investment vehicles can choose whether or not to report performance results and also which numbers to publish. When compared to the mandatory quarterly reporting of U.S. mutual funds, this brought about a strong positive bias into industry databases, Malkiel said.
Another problem, "backfiling," where hedge fund managers could report months of strong performance to a database and leave out months of mediocre returns, had helped the industry post spectacular gains. For instance, between 1994 and 2003, hedge fund returns with backfill averaged 14.29%, but 8.45% without backfill--a 584 basis point difference, according to Malkiel.
Malkiel also noted that "survivorship bias" has blurred fund data. Hedge funds have a much lower survival rate before being closed down than mutual funds. This, in turn, means that indexes end up reflecting the results of successful funds than of "dead" funds. "There was a 740 basis points difference between live funds and dead funds. If you want to get a feeling of how hedge funds have done, you also need to look at dead funds. From the standpoint of the performance of the industry, you have to look at the whole industry," Malkiel said.
Malkiel added that there is a huge discrepancy between the performance of the top hedge funds and the bottom funds, and that it's a much wider gap than the one seen for mutual funds. He also observed fewer repeat performances from successful funds, adding that repeat winners only happened, on average, about 50% of the time.