Welcome to the Dark Side

Abstract

Hedge funds exhibit a high rate of attrition that has increased substantially over time. Lack of size, lack of performance and an increasingly aggressive attitude of old and new fund managers alike appear to be the main factors behind this phenomenon. Although attrition is high, survivorship bias in hedge fund data is modest, which reflects the relatively small difference in performance between surviving and defunct funds. Concentrating on survivors only will overestimate the average hedge fund return by around 2% per annum. For small, young, and leveraged funds, however, the bias can be as high as 4%–5%. The authors also find significant survivorship bias in estimates of the standard deviation, skewness, and kurtosis of individual hedge fund returns. When not corrected for, this will lead investors to seriously overestimate the benefits of hedge funds. Fund of funds attrition is much lower. Combined with the small difference in performance between surviving and defunct funds of funds, this yields relatively low survivorship bias estimates for funds of funds.