Markov Processes International (MPI) and their clients contend that to stay relevant, indices should be representative and investable. There are reasons to question whether some existing indices meet either or both criteria, and clearly conflicts exist between the two objectives. Most existing indices are all inclusive, equally weighted and comprised of hard closed funds and a long tail of small funds, but it is not possible to access hard closed funds and not practical to maintain miniscule investments in transient cohorts of thousands of tiny funds.
MPI are also of the opinion that selection/non-reporting bias, survivorship bias, and backfill or instant history bias can all serve to artificially inflate index returns, which are often higher for non-investable than for investable hedge fund indices. According to MPI, these biases can be overcome by building a representative index comprised of a selective group of the largest funds.
“There still remains the challenge of making the index investable,” argues MPI’s Executive Vice President and Head of Institutional Solutions, Rohtas Handa. Historically, that is the step that has been missing, he adds. “Some of these indices, were not originally designed to be investable.” He elaborates that “they have often lacked stability with too much turnover, have been equally weighted, and have had over-representation of smaller managers, which is not a good model for how institutions actually invest.”