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FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

A pension fund allocates to a private credit manager that reports smooth quarterly valuations with very low volatility compared with public leveraged loans. Which conclusion is most appropriate for the fund's risk manager?

Reported volatility likely understates true risk because appraisal-based, infrequent valuations smooth returns. The risk manager should adjust, for example by unsmoothing returns or using public proxies, rather than treat the low volatility as evidence of lower economic risk.

  1. AThe low reported volatility proves the loans have lower economic risk
  2. BReported volatility likely understates true risk due to appraisal-based valuation smoothing, so risk should be adjusted, such as by unsmoothing returnsCorrect
  3. CVolatility should be ignored because private loans carry no market risk
  4. DPublic loan volatility should be reduced to match the private figure

Explanation

Infrequent, model-based marks smooth returns and bias volatility and correlations downward. Risk managers should unsmooth or use public proxies. Proving lower risk or ignoring market risk is wrong; forcing public figures down is arbitrary.

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