Managing Hedge Fund Risk and Financing: Adapting to a New Era

Stakeholders’ Rights

As the case above illustrates, investment risk does not exist in a vacuum. The structure of the fund's financing, the incentives and rights of prime brokers, investors, and staff all have an impact on the ultimate outcome and return.

These various stakeholders in the performance of the fund each have rights they can exercise over the assets of the fund. The primary stakeholders are investors, prime brokers, and hedge fund management staff. Each has different claims on the assets of the fund and earns different returns depending on the performance of the fund. Each also has specific rights that can affect the claims of the others (see Table 1.8). In a crisis, the varying rights prompt actions by each stakeholder that are individually loss-minimizing but which have negative implications for other stakeholders and result in sub-optimal returns for all investors collectively.

Table 1.8 Stakeholders’ rights and risks.

Investors’ Rights

Hedge fund investors vary from sophisticated and patient institutional investors such as pension funds and endowments, to less-sophisticated and potentially skittish high-net-worth individuals, to friends and family of the hedge fund manager. Then, there are fund of funds managers who create portfolios of screened hedge fund investments and then provide their clients (typically institutional investors and high-net-worth individuals) ...