Question #14 - Reading 34 Hedge Fund Strategies

Reading: Reading 34 Hedge Fund Strategies

PDF File: Reading 34 Hedge Fund Strategies.pdf

Page: 6

Status: Incorrect

Correct Answer: A

Your Answer: C

Shared Context

4. Volatility risk (VIX) Using monthly returns for the last 10 years, the coefficient estimates from the model and corresponding t-statistics are displayed in Exhibit 1: Conditional Linear Factor Model Coefficients for UNO. Exhibit 1: Conditional Linear Factor Model Coefficients for UNO UNO Coefficient Estimate t-Statistic Normal Times USD 0.095 0.65 CREDIT 0.015 0.12 SNP500 0.678 7.42 VIX –0.183 –2.67 Crisis Times (Incremental) DUSD 0.327 1.49 DCREDIT –0.251 –2.20 DSNP500 –0.189 –2.35 DVIX +0.054 +2.88 UNO is an equity long/short fund with the following statement in its fund documents regarding its strategy: UNO is a sector-focused long/short manager that aims to identify attractive alpha-generating opportunities on both the long and short side in the biotechnology sector. The fund uses a two-pronged approach: a team of research analysts work with the fund manager to identify the best bottom-up investments in the biotechnology sector, while macro-focused analysts work with the fund manager to apply overlay strategies using futures and options to adjust the market exposure of the fund. The analyst uses the model to assess global macro hedge fund managers in their investment universe for superior market timing skills. They base their assessment on the signs and statistical significance of the coefficients of the model. The investment committee of the corporate pension fund has asked the investment management team to review the rationale for including an allocation to hedge funds in the pension portfolio.

Question

Based on the data in Exhibit 1: Conditional Linear Factor Model Coefficients for UNO and the statement from the fund documents regarding UNO's strategy (and assuming that a t-statistic with an absolute value greater than 2 is significant), which of the following statements is most accurate?

Answer Choices:

A. The macro analysts have exhibited good market timing skill with respect to equity risk

B. UNO has been, on average, net short equity market risk during times of market crisis

C. The macro analysts have exhibited poor market timing skill with respect to equity risk

Explanation

The output of the model shows that UNO has significant long exposure to equity risk during normal market conditions (with a statistically significant coefficient of 0.678). The coefficient of DSNP500 being equal to –0.189 indicates that the manager is less long in market crises (an overall exposure of 0.678 – 0.189 = 0.489). So, there is skill by the macro analysts in reducing market risk during a crisis. The data shows market timing skill in reducing the equity market exposure during a crisis, and the data does not imply that the manager has a negative exposure to market risk during crises (as stated previously, this coefficient remains positive at 0.489).

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