1.Hedge funds are generally not required to publicly disclose their performance, however, some managers choose to make performance information available to the public. This information is then included in hedge fund indexes and some conclusions about the performance of hedge funds can be drawn. Which of the following statements regarding hedge fund performance is least accurate?

A)   In recent years, the Sharpe ratio for hedge funds has been comparable to that of fixed income investments.

B)   The reported volatility of hedge fund returns may be higher than the actual volatility of returns.

C)   When measured by standard deviation, hedge funds are less risky than traditional equity investments.

D)   The standard deviation as a measure of risk does not fully account for the unlimited downside potential that some hedge funds exhibit.

2.Which of the following statements regarding hedge fund performance is FALSE?

A)   Hedge funds have historically underperformed the S& 500.

B)   Hedge funds have demonstrated a lower risk profile than traditional equity investments.

C)   The Sharpe ratio for hedge funds has been consistently higher than for most traditional equity investments.

D)   There is a low correlation between the performance of hedge funds and traditional investments.

3.The fee structure of a hedge fund may lead to biases in performance data because:

A)   hedge fund managers are not required to disclose information regarding fee structures.

B)   fund managers have incentives to take big risks if past performance has been poor.

C)   hedge fund managers charge higher fees than managers of traditional funds.

D)   fund manager compensation can vary widely from year to year.

4.Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

A)   hedge funds as an asset class have not been in existence long enough to have meaningful performance data.

B)   there is not a reliable index that tracks hedge fund performance.

C)   hedge funds usually report returns before deducting any fees.

D)   fund managers tend to submit only favorable performance data.

1.Hedge funds are generally not required to publicly disclose their performance, however, some managers choose to make performance information available to the public. This information is then included in hedge fund indexes and some conclusions about the performance of hedge funds can be drawn. Which of the following statements regarding hedge fund performance is least accurate?

A)   In recent years, the Sharpe ratio for hedge funds has been comparable to that of fixed income investments.

B)   The reported volatility of hedge fund returns may be higher than the actual volatility of returns.

C)   When measured by standard deviation, hedge funds are less risky than traditional equity investments.

D)   The standard deviation as a measure of risk does not fully account for the unlimited downside potential that some hedge funds exhibit.

The correct answer was B)

Many assets that are included in a hedge fund portfolio are not actively traded. Managers utilize estimates to report the market value and performance of their hedge funds. Using estimates rather than actual market transactions may result in smoothed pricing, thereby reducing reported volatility. The other statements are true.

2.Which of the following statements regarding hedge fund performance is FALSE?

A)   Hedge funds have historically underperformed the S& 500.

B)   Hedge funds have demonstrated a lower risk profile than traditional equity investments.

C)   The Sharpe ratio for hedge funds has been consistently higher than for most traditional equity investments.

D)   There is a low correlation between the performance of hedge funds and traditional investments.

The correct answer was A)

Hedge funds have demonstrated a lower risk profile than equities when measured by standard deviation. The Sharpe ratio, which is a reward-to-risk ratio, has been higher for hedge funds than for equities. There has been a low correlation between the performance of hedge funds and that of traditional investments. Hedge funds have historically outperformed the S& 500.

3.The fee structure of a hedge fund may lead to biases in performance data because:

A)   hedge fund managers are not required to disclose information regarding fee structures.

B)   fund managers have incentives to take big risks if past performance has been poor.

C)   hedge fund managers charge higher fees than managers of traditional funds.

D)   fund manager compensation can vary widely from year to year.

The correct answer was B)

Hedge fund managers would report performance net of fees if at all. Hedge fund managers have the potential to earn more than managers of traditional funds, but this does not bias performance data. Hedge fund managers typically receive a modest base fee (1%) and then a large incentive fee based upon performance. If past performance has been poor, then fund managers feel they have “nothing to lose” and may invest more aggressively.

4.Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

A)   hedge funds as an asset class have not been in existence long enough to have meaningful performance data.

B)   there is not a reliable index that tracks hedge fund performance.

C)   hedge funds usually report returns before deducting any fees.

D)   fund managers tend to submit only favorable performance data.

The correct answer was D)

Hedge funds have been in existence since the early 1990’s, long enough to compile meaningful data. There are several reliable indexes designed to track hedge funds. Fund managers, when they do submit data, would report performance net of fees. One of the primary reasons why performance data has biases is that submission is strictly voluntary, so managers tend to only submit impressive performance information.