Saturday, January 21, 2006

LIES AND STATISTICS: There was an interesting story in the New York Times yesterday on hedge fund indexes.

This story points out that hedge fund "indexes" are all over the lot:

The Standard & Poor's hedge fund index, which includes funds that are open for investment, returned 2.39 percent for 2005. The Credit Suisse/Tremont Hedge Fund Index, which includes funds that are not open for investment, had a gain of 7.61 percent. Its investable index, on the other hand, returned 3.54 percent. The Hedge Fund Research index, which also includes funds not open for investment, returned 9.35 percent; its investable index showed a gain of 2.7 percent.

These numbers are screwy, and for a good reason. Since hedge funds are secretive and do not have to report their performance, you can barely call these numbers "indexes" in the accepted sense of the word. There are so many hedge funds that do not report their performance that there's no way of knowing if these indexes are statistically kosher.

Another reason hedge fund stats are worthless is that fund managers don't have to report their performance at all. A proper index would include a statistically reliable gauge of the performance of a cross-section of funds, whether they want their numbers reported or not. What would the stock indexes look like if they excluded schlock stocks didn't want to report their performance?

The Times story concludes by noting that "many sophisticated investors develop their own benchmarks, or they set an absolute return objective. Not all hedge fund investors are so sophisticated. For those who are not, and who happen to be piling into hedge funds, it is worth finding a reliable benchmark."

Might be even more worthwhile to just stay away from hedge funds entirely, as I suggest in my book.

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