Change You Can Believe In? Hedge Fund Data Revisions by SSRN
Duke University – Department of Economics
University of Oxford – Said Business School; University of Oxford – Oxford-Man Institute of Quantitative Finance; Centre for Economic Policy Research (CEPR)
University of Oxford – Said Business School; Oxford-Man Institute of Quantitative Finance
March 22, 2013
Journal of Finance, Forthcoming
Abstract:
We analyze the reliability of voluntary disclosures of financial information, focusing on widely-employed publicly available hedge fund databases. Tracking changes to statements of historical performance recorded at different points in time between 2007 and 2011, we find that historical returns are routinely revised. These revisions are not merely random or corrections of earlier mistakes; they are partly forecastable by fund characteristics. Moreover, funds that revise their performance histories significantly and predictably underperform those that have never revised, suggesting that unreliable disclosures constitute a valuable source of information for current and potential investors. These results speak to current debates about mandatory disclosures by financial institutions to market regulators.
Change You Can Believe In? Hedge Fund Data Revisions – Introduction
In January 2011 the Securities and Exchange Commission proposed a rule requiring U.S.-based hedge funds to provide regular reports on their performance, trading positions, and counterparties to a new financial stability panel established under the Dodd-Frank Act. A modified version of this proposal was voted for adoption in October 2011, and was phased in starting late 2012. The proposal requires detailed quarterly reports (using new Form PF) for 200 or so large hedge funds, those managing over U.S.$1.5 billion, which collectively account for over 80% of total hedge fund assets under management; for smaller hedge funds, these reports will be less detailed, and required only annually. The proposal states clearly that the reports would only be available to the regulator, with no provisions in the proposal regarding reporting to funds’ investors. Nevertheless, hedge funds argued against the proposal, citing concerns that the government regulator responsible for collecting the reports could not guarantee that their contents would not eventually be made public.
The economic theory literature almost uniformly predicts that providing more information to consumers is welfare enhancing (an early example is Stigler (1961), also see Jin and Leslie (2003, 2009) and references therein). Hedge funds, however, are notoriously protective of their proprietary trading models and positions, and generally disclose only limited information, even to their own investors. One important piece of information that many hedge funds do o¤er to a wider audience is their monthly investment performance. This information (as well as information on fund characteristics and assets under management),2 is self-reported by thousands of individual hedge funds to one or more publicly available databases. Under the 3(c)1 and 3(c)7 exemptions to the Investment Company Act, disclosing past performance and fund size to publicly available databases is thought to be one of the few channels that hedge funds can use to market themselves to potential new investors (see Jorion and Schwarz (2010) for example). As a result, these databases are widely used by researchers, current and prospective investors, and the media.
In this paper we closely examine hedge fund disclosures to these publicly available databases, with the goal of providing empirical evidence to underpin the current debate on hedge fund disclosure regulation. We are particularly interested in whether these voluntary disclosures by hedge funds are reliable guides to their past performance, and we attempt to answer this question by tracking changes to statements of performance in these databases recorded at different points in time between 2007 and 2011. In each “vintage” of these databases, hedge funds provide information on their performance from the time they began reporting to the database until the most recent period. We find evidence that in successive vintages of these databases, older performance records (pertaining to periods as far back as fifteen years) of hedge funds are routinely revised. This behavior is widespread: 49% of the 12,128 hedge funds in our sample have revised their previous returns by at least 0.01% at least once, nearly 30% of funds have revised a previous monthly return by at least 0.5%, and over 20% by at least 1%. These are very substantial changes, comparable to, or exceeding, the average monthly return in our sample period of 0.62%.
While positive revisions are also commonplace, negative revisions are more common and larger when they occur, i.e., on average, initially provided returns present a more rosy picture of hedge fund performance than finally revised performance. This suggests the danger of prospective investors being wooed into making decisions based on initially reported histories which are then subsequently revised. Moreover, these revisions are not random, indeed, we employ information on the characteristics and past performance of hedge funds to predict them. For example, Funds-of-Funds and hedge funds in the Emerging Markets style are significantly more likely to have revised their histories of returns than Managed Futures funds. Larger funds, more volatile funds, and less liquid funds are also more likely to revise.
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