Question

a) Provide two most important reasons why active management may not be suitable in an inefficient market. Please ensure that you explain each reason in the context of active management rather than investing in that particular market?

b) What are the two main actions and/or strategies taken by fund-of-funds Hedge fund managers to increase liquidity? Are there any negative effects of these actions?

Answer 1

A. Important reasons why active management may not be suitable in inefficient market-

I. They would be readjusting their portfolio based upon current trends and market cycles which will be not consistent in the Efficient market and that can result into a lot of loss.

II. They will not be able to beat the markets because, in the Efficient market, there would be a lot of fraudulent practices and insider trading, so they cannot have access to those prior informations.

They would be providing a lesser rate of return than the Index rate of Return and they would not be preferable by the investors

B. The funds of funds hedge funds managers will be doing these things in order to increase their overall liquidity-

A. They will be trying to increase the overall proportion of the leverege in the overall investment process and they would be trying to borrow at a lower amount of rate and they would be trying to generate higher amount of Return and differential will be increasing the cash, and thereby increasing the liquidity

B. They would be trying to invest into cheaper markets, whereas the cost of funding is lower and they are underpenetrated and emerging markets.