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

A hedge fund investor is concerned that a convertible arbitrage fund's performance resembles selling insurance: steady small gains with occasional large losses during market stress. Which measure would best capture this feature relative to using volatility alone?

Negative skewness, excess kurtosis and tail measures such as expected shortfall best capture the pattern of small steady gains and rare large losses. Volatility alone understates this exposure, which resembles selling insurance or short option positions.

  1. AExamining negative skewness and excess kurtosis of returns, along with tail-risk measures such as expected shortfallCorrect
  2. BComputing only the fund's annualized average return
  3. CComparing the fund's management fee to its peers
  4. DCounting the number of positive months in the track record

Explanation

Short-optionality-like strategies display negative skewness and fat tails that standard deviation understates. Skewness, kurtosis and expected shortfall reveal these tail losses. The other options ignore tail risk.

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