Hedge fund survivorship bias?

Hedge fund survivorship bias is frequently cited in empirical academic studies. Some claim "aggregate" hedge fund returns are overstated. Constructing a comprehensive hedge fund performance database is difficult. Many of the best hedge funds">hedge funds don't need to report. Hedge fund indices have widely differing reporting funds and some mistakenly include many beta repackagers pretending to be hedge funds">hedge funds.

Golf headlines? "Golf scores overstated", "Golfers can't break 100". Just because these are true for the ENTIRE set of people who have ever swung a driver it does not preclude the existence of individuals who through hard work and skill regularly break 70. Sports data focuses on professionals and it is time hedge fund data focused on the pros and excluded the amateurs. There is a wide ability range within the hedge fund industry. The AVERAGE fund will not be a good performer just like the AVERAGE golfer. The "aggregate" is not meaningful when standard error is enormous.

Many hedge funds">hedge funds close down or shut to new and existing investors because of SUCCESS. The manager has made enough from outstanding performance to retire. The studies are flawed because they miss POSITIVE survivor bias but the naysayers assume only negative factors behind a hedge fund ceasing to exist. A hedge fund should be evaluated on its own merits; how "all" hedge funds">hedge funds do is irrelevant.

Conclusions regarding "every" hedge fund are a waste of time. The barriers to entry are low. Anyone can get a Bloomberg, set up a Limited Partnership and call themselves a hedge fund. Most of these wannabes drag down aggregate performance and negatively affect total industry returns. Active investing is a zero-sum game so the performance of a TYPICAL hedge fund will tend towards: RISK FREE CASH minus EXECUTION COSTS minus FEES ie low single digits over the long term. However truly skilled hedge funds">hedge funds will perform much better on a risk-adjusted basis than ANY OTHER INVESTMENT PRODUCT.

Interestingly how these "overstated" hedge fund return "experts" never mention the bias inherent in their beloved "passive" equity funds. Index trackers have survivorship bias but are often compared favorably to hedge funds">hedge funds. The original stock index, the Dow, began with 12 stocks but 11 of them disappeared over time. In the 1990s Bethlehem Steel and Woolworths were Dow Industrials stalwarts; where are they now? In 2000 the Nasdaq had about 5,500 stocks and today just 3,500 or so; many of the missing went to zero but the Nasdaq index calculation ignores all those failed stocks. Why? The Nasdaq index would be much lower is the divisor included all those zeros.

Over the decades, for every survivor like General Electric GE, Coca Cola KO and Microsoft MSFT there have been hundreds of stocks that went to zero. More recently, for every Google GOOG there were numerous Pets.com's. Some equities get bought out at a premium but far more vanish through bankruptcy. The likeliest future price for a stock in the long term is ZERO. Countless public and private companies have lost 100% of their investors' capital. Remember that the next time someone tells you to hold a stock for the "long haul". The odds are very much against you.

by Veryan Allen. Copyright

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