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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A fund of funds compares two managers using a seven-factor style model including trend-following lookback straddles. Manager X shows a significant positive loading on a bond lookback straddle and alpha near zero. What is the best interpretation?

The returns are mainly explained by systematic trend-following exposure. A significant loading on a lookback straddle together with near-zero alpha shows the performance can be attributed to a replicable factor payoff, so there is little evidence of manager skill beyond that exposure.

  1. AX's returns are largely explained by systematic trend-following exposure rather than by manager skillCorrect
  2. BX has demonstrated significant skill since alpha is not negative
  3. CX's returns are uncorrelated with all traded factors
  4. DX's return is explained by backfill bias

Explanation

A significant factor loading with near-zero alpha implies returns come from a replicable, systematic risk exposure, in this case trend-following option-like payoffs, not from unexplained skill. Zero alpha is not evidence of skill, and a significant loading contradicts being uncorrelated with factors.

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