Explanation:
Absolute return funds employ a variety of strategies that are typically not replicable, making them unsuitable to be used as benchmarks. Absolute return funds aim to generate positive returns regardless of market conditions. They do this by employing a wide range of investment strategies, including long/short equity strategies, arbitrage strategies, and derivative strategies, among others. These strategies are often complex and require a high level of expertise to execute effectively. Furthermore, the strategies used by absolute return funds are often proprietary, meaning they are unique to the fund and not publicly available. This makes it virtually impossible for another fund to replicate the strategies used by an absolute return fund. Therefore, using an absolute return fund as a benchmark would be inappropriate because it would be impossible for the new fund to replicate the strategies used by the absolute return fund. This would make any comparison between the new fund and the absolute return fund meaningless.
Choice A is incorrect. While it's true that absolute return funds aim to generate positive returns irrespective of market conditions, this doesn't necessarily make them suitable benchmarks. Benchmarks should be representative of the investment strategy and risk profile of the fund they are measuring, and not all funds aim for absolute returns.
Choice B is incorrect. The assertion that absolute return funds take excessive risks is a
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Q.2414 A large investment management firm intends to launch a new hedge fund for its retail investors. The firm is in the process of identifying a benchmark which its fund would try to replicate. During a meeting of the investment management committee, the following remarks are made:
Fund manager 1: “Our firm has multiple active funds tracking different benchmarks. We must include the benchmark with the highest return as the benchmark for our new fund as this will also help us to attract new investors.”
Fund manager 2: “My research reveals that the returns for XYZ fund have been above the market return for several consecutive periods. I would, therefore, recommend the use of the market return as our benchmark, as it will clearly help us attract new investors.”
Fund manager 3: “There are many absolute return funds in the market which have consistently beaten the market. We must take one of those funds as the benchmark.”
Which of the following is correct with respect to the statement made by Fund manager 3?
A
Absolute return funds generate positive returns irrespective of market conditions and, therefore, it would be in order to use one of them as the benchmark.
B
Absolute return funds take excessive risks, a characteristic which effectively nullifies them from being used as benchmarks.
C
Absolute return funds employ different strategies which are usually not replicable, and hence one of them must not be used as the benchmark.
D
Absolute return benchmarks are usually not diversified, and hence one of them must not be used as the benchmark.