Instant History Bias

Original post

What is an ‘Instant History Bias’

Instant history bias is a reporting inaccuracy that can inflate the performance of a fund or fund manager. Instant history bias can occur whenever a fund is given the option of when to join a database or index, as well as the option to backfill some of their historical returns. Given these two options, a fund can join at a high point and select a backfill period that includes the strongest results, creating an instant history within the database or index. The instant history bias is also referred to as the backfill bias.

BREAKING DOWN ‘Instant History Bias’

Instant history bias is primarily a hedge fund industry issue. Hedge fund managers can create new funds and pick when to report on the performance to a database like the Lipper Hedge Fund Database (TASS). Basically, the hedge fund manager can wait to see if the fund will be successful given the holdings or strategy and then only list it once it proves itself, backfilling the database with the previously unreported data.

Instant History Bias and Survivorship Bias

Instant history history bias often works in tandem with survivorship bias. For example, instead of launching a new $5 million dollar long-short fund, a hedge fund manager could launch two $2.5 million dollar long-short funds with different holdings or selection strategies. The hedge fund managers then waits two or three years, managing the two funds and seeing what happens.

If the first fund does mediocre and the second fund excels, then the hedge fund manager can submit the second fund to the database with three years of strong results. Then the hedge fund manager can chose to close the unsuccessful fund, creating a clear case of survivorship bias in addition to the instant history bias. Alternatively, the hedge fund manager can keep running the mediocre fund without submitting it until it reaches a performance level that makes it worth adding to the database. If the latter approach is taken, the hedge fund manager can further increase the attractiveness of the fund and the perception of his or her investing prowess by truncating the data being backfilled to take out the first years of mediocre returns.

The Impact of Instant History Bias

Instant history bias affects the fund and the fund manager in slightly different ways. For funds, the instant history bias can give the fund a higher rank immediately and create more interest from accredited investors and funds of funds. The fund itself has an advantage in a sense, but the history being backfilled is real in the context of that fund – even if it selectively curated to omit poor results in the deeper past. From the hedge fund manager’s perspective, the instant history bias allows failures to be hidden and success to be showcased. If investors are evaluating the fund by the manager, instant history bias allows him or her to doctor the record and avoid a full accounting of overall investment performance. This is clearly an advantage for a fund manager and could be used to turn a middling manager into a superstar by only showing the winning funds. Hedge fund databases are affected differently by instant history bias, as some cap the amount of backfill that can be done and others eliminate backfilling entirely, starting even established funds at year zero when they provide results.