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

The Importance of Change

The silver lining in the most recent crisis is that the painfully negative returns which accrued to relative-return investors means that absolute-return investing is here to stay. The increasing sophistication of investors and the accelerating competition amongst hedge funds for opportunities and for investors means that absolute-return investing on a large scale will become increasingly institutionalized.

The future of the hedge fund industry is primarily driven by the discriminating demands of its investors. The losses experience by investors in the credit crisis, the unsatisfactory correlated performance of most strategies (other than CTAs) to the market, and the unsatisfactory reaction of many high-profile hedge funds to large redemption demands have put fund managers under pressure. Investors will continue to allocate capital to funds which demonstrate risk adjusted performance superior to their peers. These funds will be allowed by investors to leverage off the mistakes of their peers and extend their proven investing and risk management discipline into new strategies and geographic regions.

Alpha generation will become more difficult as a result of a widening understanding of hedge fund strategies and the progressive emergence of high-velocity versions of traditional arbitrage strategies. Competition will diminish returns. While rewards for performance will remain high, expenses will increase because of the technology and personnel investments required ...