Is the vaunted “illiquidity premium” partially an illusion?
Nov 22nd, 2009 | Filed under: Hedge Fund Operations and Risk Management, Performance, Analytics & Metrics, Today's Post
The illiquidity of alternative investments often used to explain their risk-adjusted out performance (see previous coverage on this topic here). But what if some of that risk adjusted out performance was actually the result of so-called “return smoothing”? Critics of hedge funds suggest that hedge fund managers have an incentive to mis-report returns in order to make themselves look good. Are the critics right? And if so, is the “illiquidity premium” really just a result of the mis-valuation of illiquid investments?
These are the questions tackled by a new paper written by Gavin Cassar of Wharton and Joseph Gerakos of the University of Chicago’s Booth School of Business. Cassar and Gerakos use a database of hedge fund due diligence reports (the same one used in this study) to measure the serial correlation of hedge fund returns across funds with different valuation policies.
The study contains a table that you might find interesting if you ever have to conduct due diligence on a hedge fund. Reproduced below, it shows the percentage of funds in each hedge fund strategy that use each of several different NAV calculation sources: More…
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