Unsmoothing Returns of Illiquid Funds

Kenan Institute of Private Enterprise Research Paper No. 20-05

USC Lusk Center of Real Estate Working Paper Series

Fisher College of Business Working Paper No. 2024-03-002

Charles A. Dice Working Paper No. 2024-02

The Review of Financial Studies, forthcoming

107 Pages Posted: 27 Feb 2020 Last revised: 8 Feb 2024

See all articles by Spencer J. Couts

Spencer J. Couts

University of Southern California - Sol Price School of Public Policy; USC Lusk Center of Real Estate

Andrei S. Gonçalves

Ohio State University (OSU) - Fisher College of Business

Andrea Rossi

University of Arizona - Department of Finance

Date Written: October 31, 2023

Abstract

Funds that invest in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth returns when evaluating the risk exposures of these funds. We show that funds investing in similar assets have a common source of spurious autocorrelation, which is not addressed by commonly-used unsmoothing methods, leading to underestimation of systematic risk. To address this issue, we propose a generalization of these unsmoothing techniques and apply it to hedge funds and commercial real estate funds. Our empirical results indicate our method significantly improves the measurement of risk exposures and risk-adjusted performance, with stronger results for more illiquid funds.

Keywords: Illiquidity, Return Unsmoothing, Performance Evaluation, Hedge Funds, Commercial Real Estate

JEL Classification: G11, G12, G23

Suggested Citation

Couts, Spencer J. and S. Gonçalves, Andrei and Rossi, Andrea, Unsmoothing Returns of Illiquid Funds (October 31, 2023). Kenan Institute of Private Enterprise Research Paper No. 20-05, USC Lusk Center of Real Estate Working Paper Series, Fisher College of Business Working Paper No. 2024-03-002, Charles A. Dice Working Paper No. 2024-02, The Review of Financial Studies, forthcoming, Available at SSRN: https://ssrn.com/abstract=3544854 or http://dx.doi.org/10.2139/ssrn.3544854

Spencer J. Couts

University of Southern California - Sol Price School of Public Policy ( email )

Los Angeles, CA 90089-0626
United States

USC Lusk Center of Real Estate ( email )

650 Childs Way
Los Angeles, CA 90089
United States

Andrei S. Gonçalves (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Andrea Rossi

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

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