Hedge fund Investment Risks
Each of the strategies we've looked at faces significant and differentiated risks. Certain risks are common across the strategies; some are endemic to the hedge fund business model; others are unique to certain strategies. Furthermore, each risk has varying probabilities of occurrence depending on the strategy. Lastly, each risk has a different potential loss depending on the strategy. Some risks may be frequent but small in their impact, while others can be infrequent but have disastrous consequences. Any risk-management framework developed and applied to a hedge fund must be customized to the specific strategy it pursues and focus on managing the most probable and significant risk it faces.
For explanatory purposes, the following section categorizes risks based on their sources. Risks categorized as investment risks originate from the investment portfolio and are generally germane to the securities owned by the hedge fund. Counterparty, funding and operational risks arise in large part, though not solely, from the hedge fund business model.
Types of Investment Risk
Hedge funds face a wide array of investment risks. Some are specific to certain strategies while other are simply more pronounced in certain strategies.
Idiosyncratic Risk: In portfolio theory, price changes due to the unique circumstances of a specific security, as opposed to the overall market, are described as “idiosyncratic,” “unsystematic” or “specific” risk. Most commonly in the context ...