Several studies have calculated dollar-weighted returns* for mutual funds. Research firm DALBAR, for example, finds that mutual-fund investorsearned 8 percentage points less than the annual rate of return posted by mutual funds, on average. But what about hedge fund investors? Are their dollar-weighted returns less than reported returns too?
A new study finds this to be the case. In Higher risk, lower returns: What hedge fund investors really earn, Ilia Dichev and Gwen Yu report that annualized dollar-weighted returns for hedge-fund investors are, on average, 4 percentage points less than reported return rates. For star hedge funds, the disparity is even greater: 9 percentage points. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought, conclude the authors.
* Dollar-weighted returns: It is common for mutual funds and hedge funds to report their rates of returns over various time periods. For example, one fund might say they earned 15% annually over the last ten years.
But the only investors to capture this rate of return are the few who bought at the beginning of the period and held on until the end. The majority will have bought units at different prices at different times (and sold at different prices at different times). Thus, some investors will experience lower returns than the posted rate, while others will experience higher returns.
Unfortunately, given the tendency of investors to chase performance in the fund world, more will have bought at high versus low prices (and will have sold at low versus high prices). The average investor hence will have earned less than the posted average annual return of 15% (or whatever the fund is reporting). The shortfall can be estimated by weighing returns by dollar amounts invested, which yields the dollar-weighted return.