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I was going over my notes from an Asset Pricing module yesterday and came across something interesting I hadn't thought about in a while. It was how Hedge Funds can over inflate their performance by not properly accounting for stale/out of date prices or late mark-to-marketing. And that when they evaluate their performance, they will use these stale prices (instead of the current market price) to show a divergence of exposure to the market, hence lowering their overall market $\beta$. This was empirically supported by the work of Asness, Krail and Liew when they showed hedge fund $\beta$ increasing with lagged S&P regressions.

I then thought today, how do hedge funds account for the immediate returns from short selling? I'll propose an example to clear things up. Propose a hedge fund borrows 10,000 shares of security $S$ and sells it immediately for price $P$ and time $t_{t}$. They immediately receive $10,000 \times S \times P$. Obviously, they will then use a percentage of this immediate cash to then buy back security $10,000S$ at time $T_{t+n}$ for hopefully a lower price than $P$. And their overall profit is then the difference between these 2 sums.

But if the period in which they are short happens to be when the hedge fund computes their annual returns, does this revenue boost of $10,000 \times S \times P$ get recorded in their balance sheet as returns and hence skewing their performance, even if it is technically only an open position? Or does it only get recorded on the books once they have finally closed their position?

I'm curious as to see if this is some type of accounting trick hedge funds use to inflate their performance or do they actually account for these types of trades accordingly. More than happy to provide more detail below if things need clarifying.

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    $\begingroup$ I think in general, a HF would mark all positions to the current market price. $\endgroup$
    – LazyCat
    Jun 12 '20 at 16:29
  • $\begingroup$ All positions are marked to market when an accounting period closes. That should not be confused with how the different positions are treated from a tax perspective--that may differ signficantly. That being said, monthly NAV calculations are marked to market--unless the Fund's offering documentation outlines an alternate way that is explicitly detailed before an investor decides to invest. $\endgroup$
    – amdopt
    Jun 12 '20 at 16:31

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