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From Beverly Chandler, Opalesque London

The continuing problem of measuring hedge fund performance has been addressed by the Edhec-Risk Institute in its recent study, A Suggestion for Remedying the Overstated Performance of Non-Investable Hedge Fund Indices.

The study found that hedge fund performance was regularly distorted by the inclusion of survivorship bias, the process of removing funds that fail from databases having recorded their performance and a bias to instant history which happens when the a successful fund is backfilled into a database. The study says: "These biases tend to inflate the returns posted by non-investable hedge fund indices." The two biases have been estimated to distort performance by nearly 900 basis points.

Investable hedge fund indices - based on hedge funds which are open to investment - have helped investors mitigate the effects of these biases, but investable indices cannot include all existing funds and so produce a bias of their own. The study believes that the number of underlying funds is often twenty times less than that of non-investable indices. "In these conditions, investable indices are naturally less representative than non-investable indices. Consequently, it is hardly surprising that investable indices tend to underperform their non-investable versions."

Comparing the two types of indices, the study also found striking differences between the returns of liquid and illiquid strategies. Illiquid st......................

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