Q1. 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)   When measured by standard deviation, hedge funds are less risky than traditional equity investments.

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

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

Q2. Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

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

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

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

Q3. 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)   hedge fund managers charge higher fees than managers of traditional funds.

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

Q4. Which of the following statements regarding hedge fund performance is FALSE?

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

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

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

LOS l, (Part 1): Discuss the performance of hedge funds and the biases present in hedge fund performance measurement. fficeffice" />

Q1. 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)   When measured by standard deviation, hedge funds are less risky than traditional equity investments.

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

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

Correct answer is C)

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. Both remaining statements are true.

Q2. Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

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

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

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

Correct answer is C)

Hedge funds have been in existence since the early ffice:smarttags" />1990’s, long enough to compile meaningful data. There are several reliable indexes designed to track hedge funds. 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.

Q3. 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)   hedge fund managers charge higher fees than managers of traditional funds.

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

Correct answer is C)

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.

Q4. Which of the following statements regarding hedge fund performance is FALSE?

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

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

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

Correct answer is C)

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. Hedge funds have historically outperformed the S& 500.

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