medium · FRM Part 2 Risk & Investment Management
A private fund reports quarterly returns of 2%, 2%, 2%, 2%. A public-market analogue has returns of 6%, -4%, 8%, -2%. Both have an average return of 2%.
Why might a risk manager view the private fund as riskier?
- The risk manager is biased toward liquid assets, since they are far easier to model inside standard quantitative VaR systems.
- The public fund's variance is likely caused mostly by noise traders, whereas the private fund represents pure fundamental value.
- The lack of volatility in the private fund suggests that its true losses are merely being 'pushed into the future' through smoothing.
- The private fund has higher tail risk overall because it does not benefit at all from the averaging effect of the Central Limit Theorem.
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