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FRM Part I · FRM Exam Part I · Fund Management

A hedge fund database includes only funds that currently report to the vendor. Funds that closed after poor results are deleted from the historical record. An analyst computes average historical returns from this database. Which bias is most directly present, and what is its effect on the estimated average return?

Survivorship bias is present, and it overstates average returns. Funds that closed after poor results are removed from the database, so only successful funds remain, making historical performance look better than what investors in the full population of hedge funds actually experienced.

  1. ASurvivorship bias, which overstates average returnsCorrect
  2. BSurvivorship bias, which understates average returns
  3. CBackfill bias, which understates average returns
  4. DSelection bias from lock-up periods, which understates average returns

Explanation

Deleting defunct funds removes mostly poor performers, so the remaining sample looks better than the true population. This is survivorship bias and it overstates returns. Understating would require removing good performers, which is not the case here.

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