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LOS l, (Part 2): Explain the effect of survivorship bias on the reported return and risk measures for a hedge fund database. fficeffice" />

 

Q1. Which of the following statements regarding survivorship bias in hedge funds is most accurate? Survivorship bias tends to:

A)   overstate the performance and understate the volatility of hedge funds.

B)   overstate both the performance and volatility of hedge funds.

C)   understate the performance and overstate the volatility of hedge funds.

Correct answer is A)

Survivorship bias exists because only the successful hedge funds submit performance data, thus overstating performance when the index is considered to be representative of the entire hedge fund population. Likewise, stable funds tend to succeed, while more volatile funds tend to go out of business, causing the database to tend to understate volatility for hedge funds as an asset class

 

Q2. Survivorship bias is acute with hedge fund databases because hedge:

A)   fund managers often do not have to comply with performance presentation standards

B)   funds experience higher volatility of returns than traditional investments.

C)   funds are more highly leveraged than other asset classes.

Correct answer is A)

The main reason behind the survivorship bias problem in hedge fund reporting is that hedge funds are exempt from most SEC regulations, including performance presentation standards. This lack of standards leads to many inconsistencies in reporting that are not present in other asset classes.

 

Q3. Only successful, ongoing hedge funds are included in hedge fund databases. The resulting inflation of reported hedge fund performance can be best described as:

A)   asymmetrical returns.

B)   survivorship bias.

C)   self-selection bias.

Correct answer is B)

Asymmetrical returns refers to the option-like return profiles that result from some hedge fund strategies. Self-selection bias reflects the fact that submission of data by fund managers is voluntary, and they tend to submit only impressive results. Survivorship bias does result from the fact that only successful hedge funds with ongoing operations are included in databases, thus putting an upward bias on the returns of hedge funds as an asset class.