Are Hedge Fund Managers Systematically Misreporting? Or Not?
42 Pages Posted: 8 Mar 2010 Last revised: 11 Aug 2013
Date Written: July 27, 2013
A discontinuity, or kink, at zero in the hedge fund net return distribution has been interpreted as evidence of managers manipulating returns to avoid showing small losses. Instead, we propose alternative explanations for this phenomenon. In particular, we show that incentive fees can mechanistically create a kink in the net return distribution. This mechanism accounts for almost the entire kink observed in the large, liquid Long-Short Equity style. Furthermore, we show that asset illiquidity and the bounding of yields at zero can generate distribution discontinuities as well. Therefore, we conclude that the observed hedge fund return discontinuities are not direct proof of manipulation.
Keywords: Hedge Funds, Performance Evaluation, Valuation, Risk
JEL Classification: G11, G23, G32
Suggested Citation: Suggested Citation