Due to lack of reporting requirements, there is no single, central database for aggregate performance analysis of hedge funds. Hedge funds that do report results and are included in a database may use the added recognition and legitimacy to attract new investors. This gives rise to a “self-selection bias,” since choosing to report results to a database might be related to the fund’s performance.
Hedge fund databases also exhibit “survivorship bias” from several causes. When a database is created, it cannot reflect funds that are already defunct. Funds that die or otherwise stop reporting are usually removed from an index
and its associated database, and returns from their final period (or even their entire history) may be unreported. Some index providers practice additional selection bias and will not include a small or young hedge fund. These influences generally create an upward performance bias on an index.
Ackermann et al. (1999) investigates survivorship bias and compares the performance of funds that leave databases against funds that remain. They conclude that survivorship effects on data are small, as low as 0.013% monthly. Brown, Goetzmann, and Ibbotson (1999) claim that survivorship bias has a much stronger influence. Using only non-US hedge funds, they determine bias of almost 3% per year, up to 20 times Ackermann et al.
There is a performance shortfall (not really a bias) associated with hedge funds that are included in aggregate performance data but that are closed to new investors. Hedge fund managers sometimes have an incentive to close funds since a larger-size fund incurs higher market impact costs in implementing trades, and this detracts from net return. Hedge fund managers have personal wealth invested in the fund, as well as strong return-related compensation from the fund. Traditional active funds, where management fees tend to be proportional to assets under management, are less often closed to new investors.
If closed hedge funds tend to outperform other hedge funds, then the average measured return across funds will be higher than the average return available to new investors not already enrolled in the closed funds. This creates a difference between the average return to hedge funds versus the average return available to new hedge fund investors.
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