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FRM Part I · FRM Exam Part I · Fund Management

A hedge fund starts reporting to a database in January Year 4 and, on joining, the database adds its prior 36 months of returns, which averaged 15% annually. The fund chose to begin reporting because those returns were strong. What is the main concern with using these backfilled returns in a database average?

The concern is backfill, or instant history, bias, which overstates average returns. Funds choose to start reporting after strong results and then add their favorable prior history, so the database contains a disproportionate share of good performance that was not available to investors in real time.

  1. AInstant history bias, which tends to overstate average returnsCorrect
  2. BSurvivorship bias, which tends to understate average returns
  3. CLiquidation bias, which tends to understate volatility only
  4. DSmoothing bias, which tends to overstate the Sharpe ratio only

Explanation

Funds typically begin reporting after good performance, and adding their earlier record injects favorable history into the database. This is backfill (instant history) bias and it inflates average returns. Survivorship bias concerns deleted funds, not added history.

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