Are Hedge Funds Truly Superior Investment Vehicles?

A

The statement made by Kerry Garrett, CFA, regarding hedge fund returns and their superiority as investment vehicles is as follows:

1. Hedge funds have a goal of absolute returns.
2. The high Sharpe ratio of hedge funds indicates their superiority as investment vehicles.

Let's analyze each statement individually:

1. Hedge funds have a goal of absolute returns: Hedge funds are investment vehicles that typically aim to achieve positive returns regardless of market conditions. Unlike traditional investment funds, hedge funds employ a wide range of strategies, including long and short positions, derivatives, leverage, and alternative investments, to generate returns. The objective of hedge funds is to provide investors with absolute returns, meaning they seek to generate positive returns irrespective of the performance of broader market indices or benchmarks. Therefore, Kerry Garrett is correct in stating that the hedge fund industry has a goal of absolute returns.

2. The high Sharpe ratio of hedge funds indicates their superiority as investment vehicles: The Sharpe ratio is a widely used measure of risk-adjusted return. It evaluates the excess return earned by an investment per unit of risk taken. A higher Sharpe ratio suggests a better risk-adjusted performance. However, it is important to note that the interpretation of the Sharpe ratio depends on the specific context and comparison being made.

While it is true that some hedge funds have historically displayed higher Sharpe ratios compared to other investment vehicles, it does not necessarily imply that hedge funds are universally superior as investment vehicles. The performance of hedge funds can vary significantly based on their investment strategies, risk management practices, and the skill of their managers. Additionally, the high Sharpe ratios achieved by hedge funds can be influenced by factors such as the use of leverage, illiquidity, and the ability to take advantage of unique market opportunities that may not be available to traditional investment vehicles.

Therefore, Kerry Garrett's statement that the high Sharpe ratio of hedge funds indicates their superiority as investment vehicles may be an oversimplification. It is important to consider a broader range of factors and conduct a comprehensive analysis before making definitive conclusions about the superiority of hedge funds as investment vehicles.

Based on the analysis above, the correct answer would be: A. Only the statement on return is correct.