Unsmoothing Returns of Illiquid Funds

Kenan Institute of Private Enterprise Research Paper No. 20-05

USC Lusk Center of Real Estate Working Paper Series

70 Pages Posted: 27 Feb 2020 Last revised: 27 Nov 2020

See all articles by Spencer Couts

Spencer Couts

University of Southern California - Sol Price School of Public Policy; USC Lusk Center of Real Estate

Andrei Gonçalves

University of North Carolina (UNC) at Chapel Hill - Finance Area

Andrea Rossi

University of Arizona - Department of Finance

Date Written: November 25, 2020

Abstract

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

Couts, Spencer and 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

Spencer Couts

University of Southern California - Sol Price School of Public Policy ( email )

Los Angeles, CA 90089-0626
United States

USC Lusk Center of Real Estate ( email )

650 Childs Way
Los Angeles, CA 90089
United States

Andrei Gonçalves (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Andrea Rossi

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

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