Portfolio Design: A Modern Approach to Asset Allocation

HEDGE FUND RETURNS

All mutual funds in the United States must report their returns publicly each period. Databases such as that developed by Morningstar allow investors (and researchers) to examine returns earned on the universe of mutual funds just like they can examine returns on individual stocks. Because hedge funds are offered through private placement, they cannot advertise their returns publicly. Nor is there any requirement that they report returns to official agencies. So the collection of return data is haphazard and incomplete.

Consulting firms like TASS or HFR have developed databases of returns that they sell to the investment industry. The returns are provided by the hedge funds, but only on a voluntary basis. So these consulting firms will contact all of the hedge funds of which they are aware and ask for the funds to report their returns on a regular basis. Some funds do and some don’t. Some do for a while, then don’t. Some don’t for a while, then provide backfilled returns.9

To see how incomplete these data collections can be, consider the overlap of three database providers, TASS, HFR, and CISDM as reported in Agarwal et al (2009).10 Many of the hedge funds appear in two or more of these databases, so it is important to ask to what extent is any one database capturing the universe of hedge funds? The answer is revealed in Figure 9.3 where a Venn diagram shows the overlap among the three databases.11 Only 7 percent of the funds appear in all three databases. On ...