Do Hedge Fund Managers Misreport Returns? Evidence from the Pooled Distribution

VERONIKA KREPELY POOL - Indiana University Bloomington - Department of Finance
NICOLAS P.B. BOLLEN - Vanderbilt University - Owen Graduate School of Management


We find a significant discontinuity in the pooled distribution of reported hedge fund returns: the number of small gains far exceeds the number of small losses. The discontinuity is present in live funds, defunct funds, and funds of all ages, suggesting that it is not caused by database biases. The discontinuity is absent in the three months culminating in an audit, funds that invest in liquid assets, and hedge fund risk factors, suggesting that it is generated neither by the skill of managers to avoid losses nor by nonlinearities in hedge fund asset returns. A remaining explanation is that hedge fund managers avoid reporting losses to attract and retain investors.

...Conclusions
This paper documents a robust feature of the pooled cross-sectional, time series distribution of hedge fund returns: a discontinuity exists at zero. The discontinuity is not present during the three months culminating in an audit, in factor returns commonly used to proxy for trading strategies employed by funds, or in subsets of funds that invest in liquid securities. These results suggest that some managers distort returns when possible, e.g. when fund returns are at their discretion and when their reported returns are not closely monitored. The discontinuity is present in both live and defunct funds, indicating that it is not a function of survivorship. The discontinuity persists as funds age. Taken together, our results suggest the purposeful avoidance of reporting losses.

Source :

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1018663

 

Misrepresentation of offshore hedge fund returns is rampant.

If Enron and Worldcom happen under SEC jurisdiction...
Use your imagination about offshore fraud.

80% of the world's hedge funds are registered in the Cayman Islands.
The resources of the Cayman Island authorities...
Might be %0.00000001 that of the SEC and NASD.

 

You want to recall Bear Stearns` High-Grade Structured Credit Strategies Enhanced Leverage Fund ??

 

Do not forget that a lot of instruments that hedge funds hold are tied to models and not real markets where they can be valued. And models can be tweaked to misrepresent reality. I said it before, that the holly grail of trading/investing is OPM.