Benchmarks of Hedge Fund Performance: Information Content and Measurement Biases

Posted: 27 Oct 2001  

William Fung

Maple Financial Group

David A. Hsieh

Duke University - Fuqua School of Business; Duke University - Department of Economics; National Bureau of Economic Research (NBER)

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Abstract

This paper discusses the information content and potential measurement biases in hedge fund benchmarks. Hedge fund indices built from databases of individual hedge funds will inherit their measurement biases. In addition, broad-based indices mask the diversity of individual hedge fund return characteristics. Consequently, these indices are less informative for investors seeking diversification from traditional asset classes through the use of hedge funds. This paper proposes a different approach to constructing hedge fund benchmarks. It is based on the simple idea that the most direct way of measuring hedge fund performance is to observe the investment experience of hedge fund investors themselves. In terms of measurement biases, returns of funds-of-hedge funds can deliver a cleaner estimate of the investment experience of hedge fund investors. In terms of risk characteristics, indices of funds-of-hedge funds is more indicative of the demand side dynamics driven by hedge fund investors' preferences. Therefore, indices of funds-of-hedge funds can provide additional valuable information to the assessment of the hedge fund industry's performance.

Keywords: Hedge funds, benchmarks, performance, styles

JEL Classification: G1, G11, G12

Suggested Citation

Fung, William and Hsieh, David A., Benchmarks of Hedge Fund Performance: Information Content and Measurement Biases. Financial Analyst Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=280665

William (Bill) Fung (Contact Author)

Maple Financial Group ( email )

79 Wellington Street West
Suite 3500
Toronto, Ontario M5K 1K7
Canada

David Arthur Hsieh

Duke University - Fuqua School of Business ( email )

Department of Finance
Box 90120
Durham, NC 27708-0120
United States
919-660-7779 (Phone)
919-660-7961 (Fax)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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