8
For a while I ran Morningstar’s hedge fund database.
And a grim task it was, as hedge funds delight in
gaming database providers. Consider one hedge fund
that started up in the early
1990
s:
“Four months later the fund began reporting to a data-
base, and a year after inception it reported assets
under management (
AUM
) in the top quintile of all
funds. In the mid
2000
s, the fund experienced a
troubled quarter and saw its
AUM
halve in value. It
then ceased reporting
AUM
figures. The fund’s
performance recovered, and during the last quarter of
2008
it reported a particularly good double digit
return, putting it in the top decile of funds. However,
a few months later this high return was revised
downward significantly, into a large negative return.”
The example and quote come from “Change You Can
Believe In? Hedge Fund Data Revisions,” a working
paper by professors at Oxford and Duke. As private
entities, hedge funds can pick and choose when
reporting to databases. They often report to some
databases and not others; they release some data
points and not others; and they appear and disappear
from the databases on terms that the hedge funds
find to be favorable. Worst of all, and the paper’s sub-
ject, was this: Hedge funds might not report cor-
rect performance.
In the four-year period from
2007
to
2011
, the pro-
fessors found that
49%
of hedge funds later revised
at least one of the monthly performance figures
that they submitted to the database providers. That
wouldn’t be of much concern if the revisions were
tiny. In some cases they were—only a single basis
point. However,
21%
of the funds had one or more
revisions that were at least a percentage point—a
large amount indeed.
The professors found a number of disturbing tenden-
cies with these performance revisions. More of
them were down than up. Hedge funds that had at
least one performance revision had lower future
returns than funds that did not have revisions, with
the gap between the two groups being a hefty
3
.
5
percentage points per annum on a risk-adjusted
basis. In addition, funds that had a performance revi-
sion were likelier to cease operations and liquidate.
All this suggests that hedge fund databases provide a
new data point: The fund has previously revised a
performance number. Fortunately, it is not a data point
that is necessary for mutual funds. In addition to
having much lower expense ratios than hedge funds,
mutual funds rarely revise their past performance
figures, and when they do it’s almost always a tiny ad-
justment. Receiving bad data is a rich man’s disease.
Tail-Chasing
FundFire’s headline tells the story: “Wirehouse Advi-
sors Drop Hedge Fund of Funds.” Hedge funds of
funds, or
HFOF
s, came into fashion in the middle of
the last decade. At that time, hedge funds had ter-
rific track records, as most of them had dodged the
2000
-
02
technology stock crash. They were dan-
gerous to buy individually, though, because of their
investment leverage and their risk of fraud. Thus,
the vehicle of choice for institutions and high-net-
worth investors became the
HFOF
, which prom-
ised not only to find the best hedge fund managers
but also to weed out the frauds.
The results have been weak, to say the least. Over the
past seven years, multistrategy
HFOF
s have limped
to a
0
.
75%
annualized gain in Morningstar’s database.
(The official figure overstates the record. As self-
reporting entities, hedge funds have the luxury of
being able to pick and choose when to divulge their
performance. Naturally, they tend to report when
doing well and disappear when faring poorly.) In con-
trast, every flavor of target-date mutual fund has
gained more than
4%
over that same time period.
Let’s review. Institutions and wealthy informed buyers
did their research and selected a high-cost, opaque,
Hedge Funds: Making the Rich
Less Rich
Morningstar Research
|
John Rekenthaler
