Investments, tenth edition

  Hedge Fund Performance and Survivorship Bias 

 We already know that survivorship bias (when only successful funds are included in a 

database) can affect the estimated performance of a sample of mutual funds. The same 

problems, as well as related ones, apply to hedge funds.    Backfill  bias    arises because hedge 

funds report returns to database publishers only if they choose to. Funds started with seed 

capital will open to the public and therefore enter standard databases only if their past 

performance is deemed sufficiently successful to attract clients. Therefore, the prior per-

formance of funds that are eventually included in the sample may not be representative of 

typical performance.    Survivorship  bias    arises when unsuccessful funds that cease opera-

tion stop reporting returns and leave a database, leaving behind only the successful funds. 

Malkiel and Saha find that attrition rates for hedge funds are far higher than for mutual 

funds—in fact, commonly more than double the attrition rate of mutual funds—making 

this an important issue to address.  

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   Estimates of survivorship bias in various studies are 

typically substantial, in the range of 2%–4%.  

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 Vikas Agarwal, Naveen D. Daniel, and Narayan Y. Naik, “Do Hedge Funds Manage Their Reported Returns?” 

Review of Financial Studies  24 (2011), 3281–3320. 

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 Itzhak Ben-David, Francesco Franzoni, Augustin Landier, Rabih Moussawi, “Do Hedge Funds Manipulate 

Stock Prices?”  Journal of Finance,  forthcoming, 2013. 

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 Burton G. Malkiel and Atanu Saha, “Hedge Funds: Risk and Return,”  Financial Analysts Journal  61 (2005), pp. 80–88. 

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 For example, Malkiel and Saha estimate the bias at 4.4%; G. Amin and H. Kat, “Stocks, Bonds and Hedge Funds: 

Not a Free Lunch!”  Journal of Portfolio Management  29 (Summer 2003), pp. 113–20, find a bias of about 2%; and 

William Fung and David Hsieh, “Performance Characteristics of Hedge Funds and CTA Funds: Natural versus 

Spurious Biases,”  Journal of Financial and Quantitative Analysis  35 (2000), pp. 291–307, find a bias of about 3.6%. 

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Liquidity Beta

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1.5

0.1

0.2

0.3

0.4

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A

verage Excess Return (%/month)

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0.6

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 Figure 26.3 

Average hedge fund returns as a function of liquidity risk  

 Source: Plotted from data in Sadka, “Liquidity Risk and the Cross-Section of Hedge-Fund 

Returns.” 

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  Applied Portfolio Management