Oct 14, 2009
Can you trust hedge funds?
I read today in the FT about a study related to Hedge Funds (HF) which shows how reports about performances are often misrepresenting the true facts. Stephen Brown, William Goetzmann, Bing Liang, Christopher Schwarz, respectively from NYU, Yale, Amherst and Irvine, collected data on Due Diligence (DD) reports of HF from a third party provider of this service. They show, first, that HF misreport past regulatory problems and performances more often than not. Just to cite a result, in 42% of the cases, there were "verification problems". Second, having informational conflicts in the past increases the future returns but also the probability of a fund failure. Third, lacking official audit increases operational risk. Fourth, DD reports are only asked for by investors when investing is considered, which means that people assess the quality and integrity of the firm they put money in (which is what DD are about) only slightly before the peak of returns or at the peak of the HF cash inflow. Even though they chase returns, the authors also show that they value "truthtelling" behaviour, which means, unsurprisingly, that the integrity of the management is highly appreciated by investors. This suggests that, while it is true that being successful and honest is often the best way to disclose information, if you are open to a third party auditing process investors will reward you even more.