Hedge Funds Q

Q1. Which of the following best describes the overall volatility of equity market neutral hedge funds and their correlation with equity markets? --Overall Volatility--------Correlation with Equity Markets A LOW----------------------Significant B LOW----------------------Insignificant C. HIGH---------------------Insignificant

B - Volatity is low since it is market neutral and systematic risk is essentially eliminated.

Q2. In a context of an Hedge Fund, which of the following is most likely an operational risk A. Model Misspecification B. Deficient Infrastructures C. Employee slippage

B. Deficient Infrastructures?

The correct answers are Q1. A Q2. B

How can a market neutral fund have a significant correlation with equity markets?

If I did not remember wrongly it has to do with the beta of their portfolios. In a crap market the betas are negative, severely affecting returns. But in a good market their betas while positive are not very big so the upside is quite limited.

Carson Wrote: ------------------------------------------------------- > How can a market neutral fund have a significant > correlation with equity markets? That was the exact same reaction when I saw the answer + [shouts & howls]

swaptiongamma Wrote: ------------------------------------------------------- > Carson Wrote: > -------------------------------------------------- > ----- > > How can a market neutral fund have a > significant > > correlation with equity markets? > > That was the exact same reaction when I saw the > answer + Coming fresh from the CAIA Curriculum, this is false. A long short fund has some correlation with equity markets, but a market neutral fund is a convergence fund which is subject to event risk over market risk. It is said market neutral has zero market risk.

Chalk #1 up to another poorly worded question. An equity market neutral position seeks to exploit investment opportunities unique to some specific group of stocks while maintaining a neutral exposure to broad groups of stocks. So, imagine you thought the financials would do bad in 09 and healthcare would do good. You’d short financials and long healthcare securities. When the entire market shifts, the long & shorts offset, making it market neutral. But you earn returns on the downfall of financials and gain with the increase healthcare not explained by market shift. I see it as being technically neutral and should have low market correlation, but I assumed the question asked about the high correlation to the sectors you’re long and short in. If someone can advise on the last statement I made on correlation to where I might be off, it would be greatly appreciated.

Edit: Read the question Ali

So Schweser is incorrect and will have to put it on an errata after they visit this thread. This was the 1st Concept Checker on Page-459 and I have typed the description they gave in the book Ans is ‘A’ The volatility of returns for equity market neutral and risk arbitrage funds is quite low. However, the fund returns are significantly correlated with equity market returns. So although these equity hedge funds are often successful in reducing the volatility of returns, they still have equity market exposure,

I actually haven’t read the Hedge Fund chapter yet, but my answer would have been A for Q1. Academically, I can see how the answer should be B, but the reality is that most hedge funds ended up being much more highly correlate with the equity market over the past 18 months or so than everyone had hoped, .55 was a figure I saw the other day. Now, I should qualify that this correlation was for all types of Hedge Fund strategies, not just market neutral, which undoubtedly would be lower. Obviously I am speaking somewhat anecdotally here and do not know the long term, actual correlation numbers.

pg 146 of the curriculum on Reading 51 - just above the first table has the following statement: following correlation data however clearly show that risk arbitrage and equity market neutral are SIGNIFICANTLY exposed to equity market risks though less so than Long/Short Equity. So this seems to bear out with what Schweser is saying above. From the look of things, CAIA material was probably a later reading – and hence the answer in Schweser is correct with what the CFAI wants us to know… (Another of those ones)…

yeah…another case of where academic theory does not equate with reality