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Zero Returns

It’s one of the great tokens of faith of our times, that hedge fund managers can systematically deliver superior returns – so-called ‘alpha’. Researchers from Oxford University have recently published an innovative academic paper that will arouse the curiosity of college bursars and private investors alike, seeing as it calls this belief into question. In the paper, they reveal that 40% of hedge funds mislead investors by routinely revising historic performance data. This is possibly due to the secrecy of an industry that is largely unregulated compared to listed equities or registered mutual funds. Because mandatory, audited reporting of performance has not been required of them, hedge funds have typically self-reported monthly performance figures to public databases in order to attract further investment.

The three authors, all members of the Oxford-Man Institute of Quantitative Finance, examined 18,382 hedge funds between 2007 and 2011, and found that of the 7,000 that revised their performance, the majority did so downwards. “On average, initially-provided returns present a more rosy picture of hedge fund performance that finally revised performance.” The authors, Professor Andrew J Patton, Dr Tarun Ramadorai and DPhil student Michael Streatfield, suggest that such revisions should be taken negatively by potential investors, arguing that ne reporting regulations proposed by the Securities and Exchange Commission in the US should be broadened to include private investors and not just regulators.

In a related paper, three US academics extend the inquiry to self-selection bias, namely the practice of withdrawing poorly performing funds from the voluntary datasets. By returning these ‘dead’ funds to the datasets, they reveal that the reputation of the hedge fund industry for delivering superior risk-adjusted performance for their investors is a myth. They conclude that, after fees, hedge funds deliver risk-adjusted returns of essentially zero.

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