The recent credit crisis triggered market events that were unprecedented. As the crisis swept through the financial markets, it demonstrated the fragility of the hedge fund business model and, in particular, the need for hedge funds to balance their risk taking and leverage with stable liquidity and funding. The art of generating sustainable alpha requires that gyrating market forces, funding, leverage and risk taking be kept in continual equilibrium. There is no quantifiable formula for doing so as the behavior of fund managers, investors and creditors, and the frequency and magnitude of extreme market movements cannot be predicted with a high degree of certainty. There is significant potential—but often little room—for error.
While hedge funds and their investors have learned many lessons from direct experience during the financial crisis, these have been learned in isolation and have often been hidden to minimize the potential damage to the reputation of the funds. This book has attempted to bring those lessons together and distill them so that the investment and financial community need not repeat the mistakes of the past.
In summary, these lessons include:
1. Hedge funds should practice comprehensive risk management and in many cases employ a full time risk manager. Given the risk-management capabilities required (as outlined in Chapter 2), there is a need for risk management staff at hedge funds. The dominance of investment and funding risks in the ...