Chartered Financial Analyst Level 2
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62 An analyst gathers the following information about multi-strategy hedge fund returns:
| Fund | Annualized Sortino Ratio | First-Order Serial Autocorrelation (Rho) | Maximum Drawdown |
|---|---|---|---|
| 1 | 0.8 | 21% | 18% |
| 2 | 0.9 | 16% | 20% |
| 3 | 1.0 | 12% | 16% |
Which fund is most likely to be running strategies using less liquid instruments?
Exam-Like
A
Fund 1
B
Fund 2
C
Fund 3
Explanation:
Explanation
Fund 1 is most likely using less liquid instruments because:
-
Higher first-order serial autocorrelation (21%) indicates smoother returns, which is characteristic of strategies using illiquid instruments. Illiquid assets are typically marked to model rather than market prices, creating serial correlation in returns.
-
Lower Sortino ratio (0.8) suggests poorer risk-adjusted returns when considering downside risk, which can occur with illiquid strategies.
-
Maximum drawdown (18%) is moderate but the key indicator is the high serial correlation, which is a well-known characteristic of illiquid investments.
Funds using liquid instruments typically show:
- Lower serial correlation
- Higher Sortino ratios
- More volatile but accurate pricing
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