Instant History Bias

What Is Instant History Bias?

Instant history bias, also known as "backfill bias," is a phenomenon whereby inconsistent reporting practices can unduly inflate the apparent performance of a hedge fund.

This inaccuracy stems from the fact that hedge fund managers can elect whether and when to report their results to the public. Because of this, managers often delay reporting their performance until they generate a track record of positive results. In doing so, they effectively hide the years in which they performed poorly.

Instant history is a closely related concept to survivorship bias, which further undermines the accuracy of hedge fund performance statistics.

Understanding Instant History Bias

Instant history bias is especially pervasive among hedge funds, because of the lightly regulated nature of the hedge fund industry. Although investors can theoretically research hedge fund performance statistics in databases, such as the Lipper Hedge Fund Database, the reliability of this data cannot be taken for granted. This is because the performance figures published in such databases were often submitted months or even years after they occurred, thereby giving the hedge fund manager the ability to delay or cancel publication unless their investment results are positive.

An additional phenomenon, survivorship bias, further undermines the reliability of hedge fund performance statistics. According to this bias, databases tend to overstate investment performance because they fail to take into account the investment funds which failed and thereby disappeared from the database. Similarly, benchmarks and stock indices can also give inflated results by ignoring the negative return associated with companies which went bankrupt and therefore ceased being included in the index.

In practice, instant history bias and survivorship bias often work in tandem. 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 manager could then wait for two or three years, only publishing the results of the fund that is most successful.

Real-World Example of Instant History Bias

In practice, instant history bias affects funds and their managers in slightly different ways. By delaying the publication of past years' performance until a positive track record is achieved, funds can position themselves to attract more capital from new investors. Ultimately, however, the past results do need to be disclosed, even if the timing of their publication is delayed.

For hedge fund managers, however, there are even greater opportunities to selectively inflate returns. After all, a manager has the option of selecting whether or not to publish the results of a fund altogether, potentially hiding the performance of a failed fund forever. 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.

To help combat this perverse incentive, hedge fund databases have begun to limit the extent to which hedge fund managers can backfill their results—and some have prohibited backfilling altogether. Yet despite these initiatives, the instant history and survivorship biases continue to affect the hedge fund industry's performance statistics.