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

An investment fund holds office buildings, earns rental income, and values its properties by periodic appraisal rather than daily trading. Which feature of its reported returns is most likely?

Reported volatility is most likely understated because appraisal-based values are smoothed. Appraisals lag market prices and are updated infrequently, so measured returns fluctuate less than true economic returns, which also tends to make correlations with other assets look lower than they really are.

  1. AVolatility appears overstated because appraisals change too frequently
  2. BVolatility appears understated because appraisal-based values are smoothedCorrect
  3. CVolatility is identical to that of a daily-traded real estate index

Explanation

Appraisals rely on past transactions and are updated infrequently, which smooths reported values. Smoothed values lower measured standard deviation and correlations with other assets, so volatility appears understated. Option A reverses the effect.

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