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FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags

Which feature of a hedge fund manager's strategy description would a due diligence professional most likely treat as a red flag related to strategy opacity?

Vague descriptions of the strategy and trade timing, justified by secrecy and paired with unusually steady returns, are a classic opacity red flag. They prevent investors from checking whether reported performance is consistent with the strategy, unlike disclosures of exposures, service providers or drawdowns.

  1. AThe manager explains the signal logic only in vague terms, refuses to describe how trades are timed, and claims secrecy protects the edge, while the returns stay unusually steadyCorrect
  2. BThe manager publishes a monthly letter describing the portfolio's main risk exposures
  3. CThe manager provides a detailed list of the prime brokers and administrators
  4. DThe manager discloses the fund's maximum drawdown history

Explanation

Vague, secretive explanations combined with unusually steady returns prevent independent assessment of whether returns match the strategy. The other options show transparency and support verification, so they are not red flags.

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