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Hedge-Fund Benchmarks: Information Content and Biases

Posted: 2 Mar 2002  

David A. Hsieh

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

William Fung

Maple Financial Group

Abstract

We discuss the information content and potential measurement biases in hedge fund benchmarks. Hedge-fund indexes built from databases of individual hedge funds inherit the measurement biases in the databases. In addition, broad-based indexes mask the diversity of individual hedge-fund return characteristics. Consequently, these indexes provide incomplete information to investors seeking diversification from traditional asset classes through the use of hedge funds. The approach to constructing hedge-fund benchmarks we propose is based on the simple idea that the most direct way to measure hedge-fund performance is to observe the investment experience of hedge-fund investors themselves - the funds of hedge funds. In terms of measurement biases, returns of FOFs can deliver a cleaner estimate of the investment experience of hedge-fund investors than the traditional approach. In terms of risk characteristics, indexes of FOFs are more indicative of the demand-side dynamics driven by hedge-fund investors' preferences than are broad-based indexes. Therefore, indexes of FOFs can provide valuable information for assessing the hedge-fund industry's performance.

Suggested Citation

Hsieh, David A. and Fung, William, Hedge-Fund Benchmarks: Information Content and Biases. Financial Analysts Journal, Vol. 58, No. 1. Available at SSRN: https://ssrn.com/abstract=301308

David Arthur Hsieh (Contact Author)

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

William (Bill) Fung

Maple Financial Group ( email )

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

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