Should hedge funds be cautious reporting high returns?

• Too high returns can negatively influence a fund's performance.
• We highlight the empirical relevance of this effect.
• We show that many hedge funds generate negative signals by reporting high returns.

In a recent article, Schuster and Auer (2012) show that fund managers with a certain positive performance need to be aware of the fact that too high prospective excess returns can lower the empirical Sharpe ratio of their funds. In this note, we investigate the empirical relevance of this effect. We analyse whether hedge funds being evaluated on the basis of the Sharpe ratio negatively influence their performance by reporting too high returns. Our results show that a economically significant number of hedge funds listed in the CISDM hedge fund database has at least once reported a high return causing this effect.