Do hedge funds manage their reported returns?

Agarwal, V, Daniel, N and and, Naik N (2008) Do hedge funds manage their reported returns? Working Paper. London Business School BNP Paribas Hedge Fund Centre Working Paper Series.

Abstract

We find that hedge fund returns during December are significantly higher than those during the rest of the year even after controlling for funds’ risk exposures and factor risk premiums in December. More importantly, we find that this December spike is higher for funds with greater incentives and greater opportunities to inflate returns. These results suggest that hedge funds manage their returns upwards in an opportunistic fashion in order to earn higher fees. Finally, we provide evidence that funds inflate December returns by underreporting returns earlier in the year and/or by borrowing from January returns in the following year.