Unsmoothing Returns of Illiquid Funds

Funds that invest in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth returns when evaluating the risk exposures of these funds. We show that funds investing in similar assets have a common source of spurious autocorrelation, which is not addressed by commonly-used unsmoothing methods, leading to underestimation of systematic risk. To address this issue, we propose a generalization of these unsmoothing techniques and apply it to hedge funds and commercial real estate funds. Our empirical results indicate our method significantly improves the measurement of risk exposures and risk-adjusted performance, with stronger results for more illiquid funds.

Keywords: Illiquidity, Return Unsmoothing, Performance Evaluation, Hedge Funds, Commercial Real Estate

JEL Classification: G11, G12, G23

Suggested Citation: Suggested Citation

Couts, Spencer and S. Gonçalves, Andrei and Rossi, Andrea, Unsmoothing Returns of Illiquid Funds (November 25, 2020). Kenan Institute of Private Enterprise Research Paper No. 20-05, USC Lusk Center of Real Estate Working Paper Series, Available at SSRN: https://ssrn.com/abstract=3544854 or http://dx.doi.org/10.2139/ssrn.3544854