Skip to content

FRM Part II · FRM Exam Part II · Private Markets Investing

An investor in a buyout fund observes that the fund's reported net asset value (NAV) has a quarterly standard deviation of 3%, while the listed equity index of comparable companies has a quarterly standard deviation of 9%. The investor estimates the true economic volatility of the fund as similar to listed peers. Which interpretation is most appropriate?

The reported volatility is likely understated because appraisal-based valuations are smoothed and lag market moves, creating serial correlation. This makes the fund look less risky and more diversifying than it is. Investors should unsmooth returns or use proxies before using the figures in risk budgeting.

  1. AThe reported volatility is understated because appraisal-based smoothing makes valuations lag market changes, so risk and diversification benefits are overstatedCorrect
  2. BThe fund is truly one-third as risky as listed peers because of the GP's operational improvements
  3. CThe low volatility proves the fund has a lower beta, so it should receive a higher allocation in a risk-budget
  4. DThe difference is due to leverage, which always reduces measured volatility

Explanation

Appraisal-based NAVs are updated infrequently and conservatively, which smooths returns and induces serial correlation. This biases measured volatility and correlation to public markets downward. Treating reported figures as true risk would overstate diversification and misallocate risk budget. Leverage would raise, not reduce, volatility.

Did you get it right without looking?

One question tells you little. A timed set on Private Markets Investing shows your real accuracy, how long you take and where you lose marks.

Practise Private Markets InvestingFree diagnostic mock

More Private Markets Investing questions