An analysis of fraud detection using Benford’s law and the bias ratio

Abstract

This study explores the detection of fraud within the South African hedge fund industry through the utilisation of the bias ratio and Benford’s law. An examination is conducted on a sample consisting of 83 hedge funds, encompassing both Qualifying Investor Hedge Funds (QIFs) and Retail Investor Hedge Funds (RIFs), to identify potential anomalies. Six funds with elevated bias ratios are flagged for further scrutiny, indicating possible fraudulent activities. Benford’s law is applied to corroborate these findings, revealing non-conformity in all but one of the flagged funds. The study emphasises the importance of a multifaceted approach to fraud detection, combining various metrics and methodologies to enhance the overall understanding of a hedge fund’s returns. While the bias ratio and Benford’s law offer valuable insights, their application requires careful consideration of fund type and strategy. Regulatory intervention and investor vigilance are essential for safeguarding against fraudulent activities in the hedge fund industry.