Once A Liar, Always A Liar - Hedge Fund Performance Revisions

The last few years have exposed many of the previous masters-of-the-universe for the beta-hugging, momentum-chasing, herd-like leveraged (and occasionally unethical) monkeys that they are. There are many exceptions to this rule, however, and some research by Oxford University sheds some light on how future performance of a hedge fund is considerably divergent based on that hedge fund's revision of performance in global hedge fund databases. It may seem odd to many that the performance of a fund is 'flexible' but this relates to the voluntary reporting of changes from the initial performance to the latest print for that period's performance. The research finds that since 2007, while revisions are relatively balanced (between positive and negative), funds that revised their performance have drastically lower performance (and dramatically higher fund outflows) than funds that did not 'revise' their performance. With trust being such a valuable asset nowadays, it seems giving managers a second chance has perhaps been academically proven a losing bet (Meriwether, Corzine, and many others).

The recently published paper by Patton, Ramdorai, and Streatfield of Oxford University examines the performance of hedge funds that revise prior performance with the goal of shedding light on the regulatory changes with regard voluntary versus involuntary disclosure of historical performance.

We ?find evidence that in successive vintages of these databases, older performance records (pertaining to periods as far back as ?fifteen years) of hedge funds are routinely revised. These revisions are widespread, with nearly 40% of the 18,382 hedge funds in our sample (managing around 45% of average total assets) having revised their historical returns at least once.

The abstract is as follows:

We analyze the reliability of voluntary disclosures of ?financial information, focusing on widely-employed publicly available hedge fund databases. Tracking changes to statements of historical performance recorded at different points in time between 2007 and 2011, we ?find that historical returns are routinely revised. These revisions are not merely random or corrections of earlier mistakes; they are partly forecastable by fund characteristics. Funds that revise their performance histories significantly and predictably underperform those that have never revised, suggesting that unreliable disclosures constitute a valuable source of information for current and potential investors. These results speak to current debates about mandatory disclosures by financial institutions to market regulators.

Perhaps the most telling charts, at least from our perspective, in terms of trust are:

Cumulative Alpha for funds that 'revised' performance relative to funds that never 'revised'.

And the growth in AUM via inflows and outflows shows even more disparity:

So perhaps - the great financial crisis has taught us one thing - honesty pays! Or perhaps not, as the endless stammerings of global central bankers, politicians, and self-serving strategists suggests the bigger the lie, the more likely it is to be believed by the plebeians.


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