Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which evaluation method is typically associated with alternative investments?

1. Active management evaluated against a relative return standard

2. Active management evaluated against an absolute return standard

3. Passive management evaluated against a relative return standard

4. Passive management evaluated against an absolute return standard

The correct answer is: Active management evaluated against an absolute return standard

The evaluation of alternative investments is often aligned with an absolute return standard primarily due to the unique nature and objectives of these assets. Unlike traditional investments that may focus on benchmark-relative performance, alternative investments typically aim to deliver positive returns regardless of market conditions. This focus on absolute performance allows investors to assess the effectiveness of the strategy independently of market fluctuations and benchmarks. Absolute return strategies are particularly relevant for hedge funds, private equity, and other alternative vehicles where the goal is to achieve a target return irrespective of whether major market indices are up or down. This framework is essential for investors seeking to manage risk and volatility while aiming for consistent performance. Furthermore, alternative investments often employ diverse strategies, such as long/short equity, market-neutral, or event-driven approaches, which can perform well under varying market scenarios. Evaluating these strategies against an absolute return standard provides a clearer picture of their performance capabilities and risk-adjusted returns, making it a more appropriate method of evaluation for these asset classes.