Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Risk Management Process

Evaluating the risk management process and procedures entails hybrid questions that should be answered by all levels of management of the firm. Portfolio managers and traders, as well as operations staff and risk managers, all have valuable insight for investors. Risk management–related questions should be asked as part of both the evaluation of the investment process and the operational environment of the firm.

How is Risk Measured and Managed?

Risk management is an emerging discipline at many funds. That is not to say risk was not managed well in the past. It is more a reflection on the fact that risk measurement and reporting and the decision to take action is evolving toward a more independent model that segregates risk taking and investing from risk measurement and management. Today, many funds have dedicated risk managers who report to the CIO or the CEO independently from the portfolio managers and traders. Many firms also employ independent risk service providers to report risk to investors completely independently from the firm. Some use fund accountants and administrators to achieve this goal.

Investors must first inquire about the potential risks that a strategy will expose them to in the normal course of business and then inquire about the additional idiosyncratic risks presented by a specific manager within a strategy.

Investors next might want to ask if there are written policies and procedures to monitor and measure each of the applicable ...