Accredited Wealth Management Advisor Practice Exam

Which statement regarding hedge funds and their characteristics is the most accurate?

1. Hedge funds seek to profit from market inefficiencies.

2. Hedge funds attempt to beat a benchmark.

3. Hedge funds can use leverage, but are limited to 10 times their asset base.

4. Hedge funds are often as diversified as mutual funds.

The correct answer is: Hedge funds seek to profit from market inefficiencies.

Hedge funds are designed to identify and capitalize on market inefficiencies, which is a defining characteristic of their investment approach. This typically involves employing various strategies that can include short selling, arbitrage, and using complex financial instruments like derivatives. The aim is to generate returns that are not solely reliant on market movements, allowing them to potentially profit even during down markets or when traditional investments underperform. While hedge funds may indeed attempt to outperform specific benchmarks, their primary focus on exploiting inefficiencies is what truly distinguishes them from more conventional investment vehicles. In terms of leverage, hedge funds can use it extensively, often far beyond 10 times their asset base, thereby increasing both potential returns and risks. Additionally, hedge funds usually have more concentrated portfolios compared to mutual funds, which are legally required to be diversified. This concentration further highlights their strategies aimed at specific opportunities rather than a broad diversification approach. These characteristics together affirm that hedge funds primarily seek to benefit from discrepancies and inefficiencies in the market, making the accurate statement regarding their distinguishing features the assertion that they seek to profit from market inefficiencies.