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CFA Level I · CFA Level I Exam · Alternative Investment Performance and Returns

An analyst compares the performance of a private real estate fund with a listed REIT index. The private fund values its properties using periodic appraisals. Compared with the volatility of returns based on actual transaction prices, the volatility of the appraisal-based returns is most likely:

Appraisal-based real estate returns understate volatility. Appraisers rely on lagged comparable sales and update values infrequently, which smooths reported returns, reducing measured standard deviation and correlation with other assets relative to returns based on actual transaction prices.

  1. AUnderstated, because appraisals smooth the reported returnsCorrect
  2. BOverstated, because appraisals add random valuation noise
  3. CEqual, because appraisals reflect the same underlying cash flows

Explanation

Appraisal values rely on past comparable sales and are updated infrequently, so reported values lag the market. This smoothing lowers measured standard deviation and correlation with other assets. Overstated volatility is the opposite of the effect, and the two measures are not equal.

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