Chartered Financial Analyst Level 2

Explanation

Adding a 20% hedge fund allocation would most likely result in an increase in the Sortino ratio because:

• Hedge funds typically aim to provide absolute returns with lower downside risk compared to traditional assets.

• Sortino ratio measures risk-adjusted returns focusing only on downside deviation, which aligns well with hedge fund objectives.

• Hedge funds often use strategies that limit losses during market downturns, thereby improving the portfolio's downside protection and increasing the Sortino ratio.

• While standard deviation might increase or decrease depending on the hedge fund strategy, the Sortino ratio improvement is a more consistent benefit due to the focus on downside risk management.