Why Hedge Funds Look Better Than They Are

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Brendan Byrnes: What's "survivorship bias," and how can investors learn or be worried about this?

Jack Schwager: Survivorship bias is just one of many biases, but it's the one that's better known. Survivorship bias is, you have a database of funds, an index of funds like hedge funds. The managers that do poorly, they go away and drive a cab or whatever they do, and the ones who do well continue on.

Now you look at the performance and, in some indexes, the ones who have done poorly, those numbers don't appear anymore, so what you're getting is survivorship bias -- the better ones. It's giving you a misleading picture, because it's not showing you the results of those managers who have dropped out.

That's just one example of a bias that's inherent in hedge fund indexes.

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