Do hedge fund indexes overstate average returns because bad funds can drop out whenever they want to?
Hedge funds list their returns in those databases voluntarily, so investors can see them. The databases act like a dating service. We’ve found that some of the best funds don’t report because they’re closed to new investors. Some leave the databases if they’re performing well because they no longer need the exposure. Studies have shown that twice as many funds withdraw from index databases for good performance than drop out for bad. Many people also see the fees on hedge funds and complain that they’re too high. Are they? People grew very fee-conscious in the ’90s, and it’s probably causing them to adopt hedge funds slowly. As with professional fields, there is often a strong relationship between the level of performance and level of compensation. If manager skill is the source of the return, well, you get what you pay for. Keep in mind that in general, the majority of hedge fund fees are profit sharing, which makes the fees self-adjusting. If performance declines, so will the fees. An
