Something Fishy in Hedge Fund Filings? New Research Suggests So

Hedge fund filings have always been questioned but new research suggests they may not stand up to closer scrutiny.

“For years, finance experts have put together statistical analyses that suggest something fishy is going on with some of the reported returns in a large universe of hedge funds, reports the Wall Street Journal. “New analysis conducted by Gjergji Cici of the College of William and Mary, and Alexander Kempf and Alexander Puetz of the University of Cologne adds to the questions.” The trio’s research “shows the valuations hedge funds report for their stocks in quarterly filings with the Securities and Exchange Commission are sometimes at odds with actual stock prices.” Their findings “suggest hedge funds “take advantage of lax regulation by strategically fudging equity position valuations to impress…potential or existing clients.” Cici, Kempf and Puetz are expected to present their results at the American Financial Association’s annual meeting next week in Chicago.

While there is always a margin of error in this type of analysis, the discrepancies do not appear to be random. ”The economists gathered SEC quarterly filing data on stock positions and valuations for a selection of 864 hedge-fund companies from 1999 through 2008.” They found that “roughly 150,000 of the 2.3 million disclosed positions they looked at—about 7%—showed valuations that deviated from quarter-end closing prices,” and that “for a quarter of the hedge-fund companies they examined, there were at least some deviations that were economically significant.”

“More pointedly, they found that fund companies whose holdings exhibited significant price discrepancies were more likely to report smoother monthly returns to hedge fund database providers than other funds were,” reports the Wall Street Journal. “Moreover, price discrepancies went in the direction of return-smoothing.” The Wall Street Journal explains, “In good times, valuations were marked below quarter-end closing prices and in bad times they were marked up. Investors gravitate toward funds whose performance is less volatile, and lower measured volatility also gives funds the green light to use more leverage.”

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