Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Transcript of Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Theory and Practice of
Risk Management inHedge Funds
Barry Schachter
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Overview & Summary What goes on in hedge funds
Landscape of risks
Risk Measurement
Risk Management
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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What Is a Hedge Fund Portfolios ± long/short, total return
Legal ± Unregulated?
Variety ± many funds, manystrategies
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Hedge Fund Returns
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Legal - Unregulated? SEC
Investment Advisors ± Fraud/Fiduciary
Exemption- <15 Investors; Not offeringto public
Regulatory Filings - ownership
CFTC Commodity Trading Advisor
Speculative position limits
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Legal Mutual Fund Timing/Late Trading
Canary Capital Partners LLC
AUM $700MM Millenium Partners
AUM $4B
SEC Hedge Fund Study Registration
Disclosure
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Many Funds, Many
Strategies Equity Long/Short
Relative Value Fixed Income
Global Macro
Convertible Arbitrage
Statistical Arbitrage
Event Driven
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Market Risk The risk of monetary loss arising
from an adverse move in market
prices or rates
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Market Risk Measures ±
Sensitivities I Bonds
Duration and Convexity
DV01 and Key Rate sensitivities Credit spread sensitivity
Trading/Hedging� Directional
� Curve (steepener/flattener; butterfly)
� Spread
� Relative Value
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Market Risk Measures ±
Sensitivities II Equities
Notional (GMV, NMV)
Beta (Bloomberg v. Barra)
Factor models
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Market Risk Measures ±
Sensitivities III Options
Greeks (delta, gamma, vega, theta,
rho) Trading/Hedging
� The long vol trader (love gamma, hatetheta)
� The short vol trader
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Risk Measurement - VaR Motivation for
Definition of
Types of
Troubles with
Reliant on historical data
Assumptions about factor returns
Pricing models
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VaR at Hedge Funds -
Challenges Strategies that are flat at the close
Market-neutral strategies
Arbitrage/convergence strategies
Merger arbitrage strategies
Liquidity risk for ³chunky´ positions
Collateral-at-risk
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Risk Measurement ± Stress
Testing Motivation (complement VaR)
Types of stress tests
Examples of scenarios
Potential Pitfalls
Relation to VaR
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Operational Risk The risk of monetary loss resulting
from inadequate internal processes.
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Operational Risk Example Phoenix Research and Trading
$125MM losses ± January 2002
Trading US Treasuries
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Operational Risk Example Allfirst Financial ± John Rusnak
$690MM losses ± February 2002
Trading major currencies
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Operational Risk Example Lipper Convertibles LP (2/21/02)
Convertible arb fund
Assets plunged 40%, not up ³a few´ percent
Revised managers¶ valuations after
they left Delta hedges not adequate
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From Measurement to
Management Be proactive not reactive
Create risk management culture
Align interests (the ³free put´)
Have independence and authority
Establish credibility and trust
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Elements of Risk
Management Understand range and magnitude of
risks
Know what you don¶t know
Communicate issues clearly
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Getting Inside a Trader¶s
Head Entry (timing, catalyst, technicals)
Sizing (look for confirmation, scaling
in)
Position management
Exit (stops vs. price targets)
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What Worries Me - Options Unmeasured risks (pin, knockout, corr.)
No marks (price/vol)
Dealer/trader supplied marks Trader risk management
³It¶s a lottery ticket´
³I sold the option to reduce my cost´
³I can trade out of a short vol position´
³The most I can lose is the premium´
³I exercised, because I want to exit´
³I sell calls to cut my risk´
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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What Worries Me - Liquidity Volume
Firm position
Market players
Short interest
Technical stops and the rush to exit
When the market stops trading
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What Worries Me - Traders Hubris
³I have never lost money before´
³There are a million reasons for this to work´ Style drift
Market view takes over
Losers become long-term trade ideas
Doubling-down
Focus ³I will just allocate 1% of capital´
³I don¶t want to hedge the FX exposure´
8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Managing Up Communication
Keep message simple
Be clear (accuracy less important)
Overview
Monitor risk appetite
Evaluate performance
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8/6/2019 Hedge Fund (2v2 - Theory and Practice of Risk Management in Hedge Funds)
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Conclusion Successful risk management is in
the details
Subjective component of riskmanagement looms large
The only constant is change