Which of the following is a limitation of the Sharpe ratio for hedge fund performance?

The Sharpe ratio, which measures the risk-adjusted return of an investment, has several limitations when applied to hedge funds. One significant limitation is that it can be considered time-dependent. This means that the Sharpe ratio is influenced by the period over which returns are calculated. In the context of hedge funds, where performance can vary dramatically over different market conditions, a Sharpe ratio derived from a specific time frame may not accurately reflect the fund's long-term risk-adjusted return.

For instance, if a hedge fund experiences a period of high volatility followed by lower volatility, the calculated Sharpe ratio during these periods may not provide a stable or reliable indicator of the fund's expected future performance. Because hedge funds can employ various strategies that react differently to market changes, a short-term analysis may misrepresent their true risk exposure and return potential.

In contrast, the other choices present factors that do not directly speak to the core limitation of the Sharpe ratio related to time dependency. For example, while it might be argued that the Sharpe ratio assesses liquidity risk indirectly through the volatility of returns, this is not a primary feature of its calculation nor a recognized limitation. Similarly, aspects like measuring returns over short periods or relative calculations do not encapsulate the broader issues