Krissy Steele, CFA, manages money for high net worth individuals. Steele develops unique investment policies for all of her clients and uses various investment funds to construct portfolios. However, Steelehas been reluctant to use hedge funds. Which of the following statements made by Steele is least likely to be correct?
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A. B. C.B
Let's analyze each statement provided and evaluate its likelihood of being correct:
A. The volatility of historical returns associated with hedge fund indexes understates their true risk level.
Explanation: Hedge funds are known for their potential to generate high returns but also carry significant risks. This statement suggests that the volatility of historical returns for hedge fund indexes does not accurately reflect their actual risk level. It implies that the historical data understates the true riskiness of hedge funds. This statement is likely to be correct because hedge funds often employ complex investment strategies and use leverage, which can lead to significant volatility and downside risk. Therefore, the statement is likely to be correct, as it highlights the potential for hedge funds to be riskier than what is indicated by historical returns.
B. Hedge fund returns are normally distributed.
Explanation: The normal distribution, also known as the bell curve, assumes that data points are symmetrically distributed around the mean, with most observations clustered in the middle and fewer observations in the tails. This statement suggests that hedge fund returns follow a normal distribution pattern. However, this statement is least likely to be correct. Hedge fund returns are often characterized by non-normal distribution patterns. They can exhibit skewness (asymmetric distribution) and kurtosis (fat tails), meaning that extreme positive or negative returns occur more frequently than would be expected in a normal distribution. Hedge funds' unique strategies and investment approaches can result in non-linear and non-normal returns, which deviate from the assumptions of a normal distribution.
C. Published information on hedge fund returns is based on incomplete historical data.
Explanation: This statement suggests that the available information on hedge fund returns is based on incomplete historical data. It implies that the data used to assess hedge fund performance is limited or lacking, potentially hindering accurate analysis. This statement is likely to be correct. Hedge funds are often private investment vehicles, and their returns are not as transparent or readily available as those of traditional investments such as stocks or bonds. Limited disclosure requirements and reporting standards for hedge funds can make it challenging to access comprehensive historical data. Therefore, it is plausible that the published information on hedge fund returns may be incomplete or provide a limited view of their historical performance.
In summary, among the given statements, the one least likely to be correct is:
B. Hedge fund returns are normally distributed.
This statement contradicts the typical characteristics of hedge fund returns, which are often non-normally distributed due to the unique strategies and investment approaches employed by hedge funds.