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

Chapter 2

An Integrated Approach to Hedge Fund Risk Management

What differentiated many of the surviving funds from those that invoked their gates and ultimately closed? All funds practiced some form of risk management, whether they had a dedicated risk manager or not. In most cases, traders embedded risk management discipline in their investment activities. They sized their positions to ensure that the potential negative impact on their strategy was proportional to their confidence in their positions. They hedged out unintended and unrewarded risks. They monitored their position liquidity and they liquidated positions when they hit their stop-loss limits. Portfolio managers acted as risk managers at the portfolio level ensuring that capital was allocated to strategies more likely to be successful given the macro environment, and ensuring that concentrations in specific companies, sectors, countries and asset classes did not develop across strategies and that a minimum level of cash was maintained.

Funds that had a dedicated risk manager tended to have more institutionalized risk-management capabilities and formal risk-measurement systems yet still fell short of having a complete risk framework. Often, a full suite of risk analytics was available to portfolio managers, describing in great detail the potential risks of the investment portfolio. All variants of value at risk analysis, scenario analysis, concentration reports, liquidity analyses, all manner of risk adjusted performance ...