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Hedge Funds: Risk and Return Atanu Saha, Ph.D. Managing Principal Analysis Group, New York BOSTON DALLAS DENVER LOS ANGELES MENLO PARK MONTREAL NEW YORK SAN FRANCISCO WASHINGTON Topics Topics Two Principal Sources of Bias in Hedge Fund Returns: Backfill and Survivorship Persistence of Fund Performance Demise or Success: Why hedge funds stop reporting Implications for Investors Research Papers: Hedge Funds: Risk and Return, by Burton Malkiel and Atanu Saha, Financial Analysts Journal, December 2005 Do Hedge Funds Stop Reporting?, by Alex Grecu, Burton Malkiel, and Atanu Saha, April 2006 22 The Importance of Hedge Funds The Importance of Hedge Funds At the end of 2005, more than $1 trillion U.S. dollars were invested in hedge funds around the globe. Market makers on the floor of the New York Stock Exchange have estimated that during 2004, trades by hedge funds often accounted for more than half of the total daily number of shares changing hands. Investments in hedge funds have become an important part of the asset mix of institutions and even wealthy individual investors. 33 A Preview of Our Key Findings A Preview of Our Key Findings The putative argument for investing in hedge funds is straightforward: With higher rates of return and lower risk, they appear to be more attractive than the general stock market. The empirical evidence in our research suggests that hedge funds are far riskier and provide lower returns than are commonly supposed. Although some hedge funds have provided generous returns, investors face the risk of buying poorly performing funds, or worse, failing ones.