From Q bank. I think all of them are correct?
William Jones, CFA, has a client who wants to invest in a hedge fund. Jones might recommend a fund of funds instead of a single fund for all of the following reasons EXCEPT a fund of funds:
A) would be more liquid. B) may serve as a better indicator of aggregate performance of hedge funds. C) would have a lower correlation with equity markets.
I think the answer would be A because a FoF may include illiquid funds as well and the remaining two options seem to be correct.
C
A
It’s A - FoF’s have an additional layer of liquidity terms and tend to have longer notice periods ands lower redemption frequencies than stand alone HFs.
B is correct for obvious reason.
C is correct as the different strategies within the Underlying Funds will provide greater diversification benefits and reduce correlation with the market.
Kaplan Answer: C (Not sure everyone agrees or not…)
Fund of funds are usually considered good choices for individual investors because they offer diversification, usually offer more liquidity, and suffer from less survivorship bias thus they may serve as a better indicator of aggregate performance of hedge funds. One problem with fund of funds is that they are usually more correlated with equity markets than an individual fund, and this lowers their ability to diversify the overall portfolio.
definitely C. Zubbo is right that "FoF’s have an additional layer of liquidity terms and tend to have longer notice periods ands lower redemption frequencies than stand alone HFs. ", which makes at a reason the advisor WOULD recommend it to a client - the question is looking for reasons he would NOT recommend an FoF. I wouldn’t say B is obvious, but yeah, the text even explicitly states that since an FoF is an investment in multiple hedge funds, it is a better indicator of aggregate performance. That said, I don’t know why that’s a selling point - for me it would be more appealing to get one that is poised for superior performance, but whatever. In terms of having lower correlation with equity markets… I would think that pooling more and more hedge funds together would end up producing returns that are more closely correlated with broader equity returns than picking one random hedge fund, particularly if it has a weird strategy, like merger arbitrage, Emerging Markets, or distressed securities investing.
C
Schweser needs to set the question up a little better. We don’t even know what asset classes the funds are investing into.
I meant the additional liquidty terms make them more illiquid…By virtue of being a FoF, it’s redemptions terms have to be > or at a minimum equal to the underlying Funds in order to redeem their holdings and repay the investor.
I can see it being C as having more underlying equity HFs would make the FoF more correlated with the general market vs 1 HF.
In either case, I would check if there’s an errata on this question.
This question sucks.
You guys are overthinking it. It’s a very easy and direct question. Dont add false premise to the question.