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CFA Level I · CFA Level I Exam · Alternative Investment Features, Methods, and Structures

An analyst notes that a private real estate fund reports smoothed, appraisal-based returns with low volatility. Relative to the true economic risk, the reported standard deviation and the correlation with public equities are most likely:

Both are most likely understated. Appraisal-based valuation smooths and lags price changes, reducing measured standard deviation and the measured correlation with public equities. This makes the asset look less risky and more diversifying than its true economic exposure suggests.

  1. Aboth overstated
  2. Bunderstated, with correlation overstated
  3. Cboth understatedCorrect

Explanation

Appraisal smoothing spreads price changes over time, which lowers measured volatility. It also lags market moves, so measured correlation with public markets is lower than the true value. Both are understated, which makes diversification look better than it is.

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