Unobserved Performance of Hedge Funds

We investigate hedge fund firms' unobserved performance (UP), measured as the risk-adjusted return difference between a firm's reported gross return and its portfolio return inferred from its disclosed long-equity holdings. Firms with high UP outperform those with low UP by 6.36% per annum on a risk-adjusted basis. UP is negatively associated with a firm's trading costs and positively associated with intraquarter trading in equity positions, derivatives usage, short selling, and confidential holdings. We show that limited investor attention can delay investors' response to UP and lead to longer lived predictability of fund firm performance.