1. An endowment is evaluating an investment into a climate fund called Fire & Ice (F&I). Their best estimate is that F&I will have a Sharpe ratio (SR) in the future of 0.25, an annualized volatility of 85%, and that its correlation with the return of the endowment fund will be 0.5 because F&I pursues strategies that the endowment is not currently exposed to. They also believe the SR of the endowment fund is 0.45. They are concerned that investing in a lower SR investment will degrade the Sharpe ratio of the endowment fund. What do you advise them?
   1. Without knowing the expected returns for F&I and for the endowment, you cant really offer any advice.
   2. You believe investing in F&I, with its very high annual volatility of 85% is too risky for the endowment, and they should simply stay away from this fund.
   3. The test of whether a new security increases the Sharpe ratio of the portfolio you are adding it to depends not only on the securitys SR but also on its correlation with the portfolio. However, here the correlation is too high, and adding even a little F&I will decrease the SR of the endowment.
   4. The test of whether a new security increases the Sharpe ratio of the portfolio you are adding it to depends not only on the securitys SR but also on its correlation with the portfolio. Here the correlation is sufficiently low, and adding some F&I to the portfolio should increase the endowments SR.