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

Minimum Risk management Capabilities by Risk Type

Effective risk management requires that the hedge fund manager recognize and understand the source of profits and losses the fund is earning or can potentially incur (that is, the risks to which the fund is exposed). Consequently, one of the primary responsibilities of the risk management team is to identify, prioritize, quantify, and manage the sources of risk.

Investment Risk

A hedge fund manager must employ a consistent framework for measuring the risk of loss for a portfolio (and relevant subcomponents of the portfolio). To manage the risks that the hedge fund faces, its risk management team needs to produce pertinent, timely, useful, and accurate measures of investment risk. Generally, a series of expected loss estimates with defined probability of occurrence, stress test results, and scenario analyses are required. Depending on the fund's strategy or breadth of strategies, different risk analysis models may be appropriate. While the choice of framework or model for measuring risk should be left to each hedge fund manager, each model has structural limitations and these must be properly understood to ensure that models are not mis-specified and applied to portfolios for which the analysis is not robust or inappropriate. For example, measuring the degree to which the portfolio is concentrated (for example, the percentages of the portfolio allocated to the same or similar asset classes, risk factors, or geographical regions) ...