Canadian Securities Course (CSC) Level 2 Practice Exam

What is a benefit of hedge funds related to their correlation with traditional asset classes?

1. Manager risk and complex strategies.

2. Low correlation with traditional asset classes.

3. Liquidity constraints and business risk.

4. Lighter regulations (oversight).

The correct answer is: Low correlation with traditional asset classes.

Selecting low correlation with traditional asset classes as the benefit of hedge funds is indeed a strong choice. Hedge funds are designed to be less influenced by market movements affecting traditional investments such as stocks and bonds. This characteristic allows investors to diversify their portfolios effectively. The low correlation means that when traditional markets are performing poorly, hedge funds may still generate positive returns or exhibit reduced volatility, thereby providing a cushion against downturns in those markets. Moreover, this low correlation can enhance overall portfolio performance by potentially improving risk-adjusted returns. It allows investors the opportunity to achieve more stable returns over time since hedge funds may employ a variety of strategies that do not react similarly to standard market forces. Other options reflect aspects that are connected to hedge funds but do not specifically highlight the distinct benefits associated with their correlation to traditional assets. Manager risk and complex strategies pertain more to the operational risks and strategic decisions within hedge funds; liquidity constraints and business risks refer to the structural challenges that can arise in hedge fund investments; while lighter regulations indicate the level of scrutiny hedge funds face compared to more traditional investment vehicles. However, none of these options directly link to the advantageous aspect of low correlation that hedge funds can provide in a diversified investment strategy.