CFA Level I · CFA Level I Exam · Hedge Funds
An analyst compares a hedge fund's strategy with a long-only equity fund and notes that the hedge fund's return distribution shows a high Sharpe ratio, negative skewness and excess kurtosis. Relying on the Sharpe ratio alone for evaluating this fund would most likely:
Relying on the Sharpe ratio alone would most likely overstate risk-adjusted performance. Standard deviation does not capture negative skewness and excess kurtosis, which signal larger, more frequent extreme losses, so the fund's tail risk is hidden and it appears safer than it really is.
- Aoverstate the fund's risk-adjusted performance.Correct
- Bunderstate the fund's risk-adjusted performance.
- Cgive an accurate measure of risk-adjusted performance.
Explanation
The Sharpe ratio uses standard deviation only and ignores tail risk. With negative skewness and fat tails, large losses are more likely than a normal distribution implies, so the ratio makes the fund look better than it is.
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