Managing Hedge Fund Managers: Quantitative and Qualitative Performance Measures

CHAPTER 5

Risk in Hedge Funds

Risk Is like the Weather: Everyone Talks About It, but No One Does Anything about It

 

 

Risk and risk management are tricky subjects for the hedge fund industry because risk is typically viewed in mathematical terms, which makes it convenient to view but not always informative or even accurate.

Risk is one of the most overused and misunderstood terms. Factions that wish to have a much higher level of regulation are always cautioning about the risks of hedge funds. If one reviews a 10-year period ending June 30, 2008, for risk/return profile as measured by annual total returns and standard deviation (see Table 5.1), hedge funds have one of the best risk/return profiles of any asset class. Depending on the headline of the moment, risk can be in transparency, leverage, liquidity or investment vehicle, all of which require a separate view of the problem. Members of the media are always wringing their hands over the risks of hedge funds whenever one fund has a spectacular meltdown and is forced to close. The headline grabbing risks are typically limited to investment or operation risk. Yes, Bayou, Long-Term Capital Management, and MotherRock all proved to be risky investments, for different reasons. The actual causes of the meltdowns are not always well defined or understood. What is ignored is that they turned out to be no more risky than common stock blow-ups like Enron, WorldCom, or the multitude of dot-coms, or dot-bombs as they’ve become known. The ...