Evaluating Risk-Adjusted Hedge Fund Performance

Very Hard Performance Evaluation Risk-adjusted Performance

As a portfolio manager, you are tasked with evaluating the performance of a hedge fund that employs a market-neutral strategy over the past three years. During this period, the fund generated annualized returns of 8%, 6%, and 10%, with annualized standard deviations of 4%, 5%, and 7% respectively. The risk-free rate remained consistent at 2% throughout this period.

To compare the fund's performance against a benchmark, you decide to compute risk-adjusted performance measures including the Sharpe ratio and the Sortino ratio. Given that the benchmark has consistently returned 7% with a standard deviation of 6%, what would be the most appropriate assessment of the fund's performance based on the calculated values of these ratios?

The hedge fund has outperformed the benchmark, illustrating superior risk-adjusted performance as indicated by a higher Sharpe ratio.

The hedge fund's return is lower than the benchmark’s return but performs better on a risk-adjusted basis if the Sortino ratio exceeds that of the benchmark.

Both the Sharpe and Sortino ratios indicate underperformance relative to the benchmark, regardless of absolute returns.

Hint

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