GLOBAL – A new report has cast doubt on the reliability of hedge fund performance information voluntarily disclosed by the industry.
Furthermore, the report said hedge funds that had previously revised returns were more likely to underperform funds that had never revised their returns, echoing a similar survey from last year. It concluded that there was a far greater risk of experiencing a large negative return when investing in a revising fund.
'Change you can believe in? Hedge fund data revisions', published by the the Europe-wide research network Centre for Economic Policy Research based its findings on the monthly investment performance figures of US-based hedge funds, as reported to publicly available databases.
Hedge funds report these figures voluntarily, partly as a way of marketing themselves legally, since the US Securities and Exchange Commission (SEC) rules prohibit advertising by hedge funds.
The report's authors Andrew Patton, Tarun Ramadorai and Michael Streatfield said: "Tracking changes to statements of historical performance recorded at different points in time between 2007 and 2011, we find that historical returns are routinely revised."
"This behaviour is widespread," the authors continued. "Nearly 40% of the 18,382 hedge funds in our sample have revised their previous returns by at least 0.01% at least once, over 20% have revised a previous monthly return by at least 0.5%, and over 15% by at least 1%."
The report noted that the changes were substantial ones, comparable to – or exceeding – the average monthly return in its sample period of 0.64%.
While positive revisions were also commonplace, the report said negative revisions were more likely and larger when they occurred. In other words, initially provided returns presented a more positive picture of hedge fund performance than finally revised performance.
"This suggests the danger of prospective investors being wooed into making decisions based on initially reported histories which are then subsequently revised," the report said.
It further found that these revisions were not random.
The authors also employed information on the characteristics and past performance of hedge funds to predict changes to information.
"For example, funds of funds and hedge funds in the emerging markets style are significantly more likely to have revised their histories of returns than managed futures funds," the authors said. "Larger funds, more volatile funds and less liquid funds are also more likely to revise."
And they added that while many revisions were innocuous, certain others should be interpreted as negative signals by investors.
According to the authors, revising funds on average significantly underperformed non-revising funds. They added that there was a far greater risk of experiencing a large negative return when investing in a revising fund.
"This method reveals in real time that funds with unreliable reported returns are likely to underperform in the future.
"Our analysis suggests that mandatory, audited disclosures by hedge funds, such as those proposed by the SEC in 2011, could be beneficial to investors and not just regulators," the report concluded.