Survivor Bias in Hedge Funds

Posted on 11/27/2019

More institutional investors on the pension and sovereign fund side are taking a greater look at survivor bias when it comes to investing in hedge funds. Hedge fund data can be manipulated and prone to various biases. When institutional investors analyze hedge funds, longer-time periods are generally preferred. Longer market cycles and weeding out short-term trends are some of the benefits using longer-term time periods when analyzing hedge funds.

The downside of longer-term period analysis is that it poses a greater risk for survivorship bias, which impacts aggregate hedge fund performance data. Survivorship bias occurs when databases exclude the returns of funds that have closed or gone out of business, thus making the asset class look more attractive to others. Survivorship bias is present in the returns of mutual fund, but this is exacerbated in hedge funds, since they have a much higher shut down rate. One can infer that the majority of hedge fund managers who exited the universe of returns were underperforming.