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Stale price can distort hedge fund returns

Hedge funds may be fresh and new, but some of their pricing is decidedly stale, a leading US-based researcher says.

Tuesday, November 20th 2001, 10:44PM

by Philip Macalister

Investors need to be wary of some of the hedge fund performance numbers which are being advertised bin the market place.

Frank Russell's managing director of investment policy and research Andy Turner says hedge funds are difficult to analyse as there are a wide range of funds and some of the information provided about the funds is less than adequate.

"Frankly they pose a lot of problems," he says.

Turner says problem areas including stale pricing, fee distortions and the use of short or unreliable data series.

The amount of money allocated to hedge funds has grown significantly in the pat year or so. Current estimates are that there are more than 5000 hedge funds available and a new one is, on average, being launched every day in the United States. Currently about US$600 billion is invested in this sector.

Turner says as the sector grows managers are starting to look for new opportunities and are now investing in illiquid assets and thin markets. Consequently these assets aren't traded regularly and valuations are done on a "best guess" basis.

He says the actual price a fund may get for these assets when they sell them maybe much less than what the best guess valuation is.

Turner says a soon-to-be published piece of research says on the pricing methods throws up some interesting questions for investors.

The report says that in situations where an asset is hard to price, or the prices are stale, the true price of a security is an average of the prices around the pricing date. Likewise the true returns and risk is also the average around the pricing date.

This research has been used to analyse the big excess returns produced by six types of hedge funds.

The results show that the funds, "can't add value at all," Turner says.

"These are money losing machines at a high rate."

Type of fund

Returns before analysis

Returns after analysis

Aggregate Hedge Fund Index



Convertible arbitrage



Event driven



Equity market neutral



Fixed income arbitrage







Turner says the researchers concluded "hot performance is mostly an artifact of stale pricing."

Only one of the six types of funds had positive returns after the analysis and all six groups lost economically significant amounts of alpha, or excess return.

Russell took the research further and analysed the individual managers within each universe to determine what percentage of managers added value after stale pricing was taken into account.


Type of fund

% of group with positive alpha

% of group with positive alpha after adjustment for stale pricing

Aggregate Hedge Fund Index



Convertible arbitrage



Event driven



Equity market neutral



Fixed income arbitrage







Turner says while the results were "directionally the same" they were not as dramatic. He says it makes a big difference which fund you look at and it is hard to draw conclusions of this group as a whole.

"Individual manager data looks very different from the aggregate," he says.

Turner says one of the other issues with stale pricing is how it is applied.

A cynic might argue that hedge funds can use infrequent pricing to manage their reported returns.

He says the research suggests that stale pricing becomes more stale in a down market than an up market.

However, Turner thinks to be fair it is necessary to look at the issue on a fund by fund, and strategy by strategy basis, as opposed to making generalisations.

Turner isn't against hedge funds per se, in fact Frank Russell run their own fund. Rather hedge funds strain existing measurement and analytical methods, and extensive qualitative assessment needs to be done on individual managers.

He says hedge funds are a legal structure which allows unconventional investment strategies to be used.

They represent a new form of active management in traditional asset classes.

The research on stale pricing, known as the Multibeta Approach, was done by Asness, Krail and Liew, and is to be reported in a forthcoming Journal of Portfolio Management.

You can read Philip's blog here: http://www.goodreturns.co.nz/blog/

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