A bias (distortion) that results from a lack of liquidity and a lack of marking to market value. This bias is caused by the need to smooth returns when investing in illiquid assets. In other words, this situation arises when hedge funds use stale prices to mark to market their holdings. Hedge funds invest part of their money in highly illiquid instruments with stale or managed prices. As such, they smooth their returns and can manipulate Sharpe ratios.

The prices of the underlying assets are marked infrequently and/or based on estimation, and hence they are smoothed across time.