Managing Risk In Alternative Investment Strategies - Hedge Funds

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Managing Risk in Alternative Investment Strategies: Hedge Funds

description

A description of Alternative Investment Strategies from economist and finance professional Mark Tuminello.

Transcript of Managing Risk In Alternative Investment Strategies - Hedge Funds

Page 1: Managing Risk In Alternative Investment Strategies - Hedge Funds

Managing Risk in Alternative Investment Strategies: Hedge Funds

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Alternative Investment Strategies (AIS) exist across a variety of different asset classes

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(including equity, fixed income and foreign exchange) on both a directional and non-

directional basis.

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Hedge Funds, the classic example of an AIS investor take advantage of a flexible approach

to...

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multiple asset classes, trading styles, markets, leverage, short-selling and liquidity.

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Typical investors include high net worth and institutional investors i.e.

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pension funds and endowments (longer term view, high levels of risk aversion, who emphasis

stability of investment returns).

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An understanding about how past returns were generated is imperative to successful asset

allocation.

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Past performance may not evidence potential risk factors.

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Access to regular information about a manager’s trading activities allows not only for

changes in style,

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but can also help to quickly recognize and address any undesired bets or leverage

increases.

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Investors must understand how numerous macroeconomic factors influence the

performance of the individual strategies.

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The systematic market risk of the individual strategy sector is what earns most strategies their return in the form of a risk premium.

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In pursuing sector and manager diversification,

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an investor needs a detailed understanding of the correlations between strategy sectors and

asset classes in different market environments.

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A thorough understanding of the market conditions that might reduce a manager’s

edge...

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would have enabled investors to exit Long Term Capital Management prior to its collapse.

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Reported NAVs often do not take into account the liquidity of open positions,

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especially when a position is large compared to daily trading volume of the asset (such as that

of Distressed Debt).

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Suitable sector allocation can be ensured through clear investment objectives, performance targets

and well defined risk parameters.

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Hedge fund managers monitor the interrelated exposure to market risk (including asset risk),

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funding liquidity risk, credit risk (debt investments, counter-party risk) and

operational risk.

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Investor concerns include broad and diverse asset risk (heterogeneity),

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lack of transparency, and low liquidity (relatively long redemption periods often at the

option of AIS managers).

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In order to cope with the risk of a severe loss, continuous monitoring of exposures and risk is

necessary,

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permitting the early identification of any deviations from a stated strategy.

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Effective risk management begins with the ability to control.

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“Blackbox” investing is more and more unsuitable from either a fiduciary or principal

perspective.

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The threat of being copied or actively traded against had come largely from the dealer

community

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and the investment bank proprietary trading desks rather than from AIS allocators or direct

investors.

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This risk may be abating due to the Volcker Rule, or simply moving to newer or different

platforms.

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However, increased risk resulting from previously known and accepted exposures,

cannot be entirely eliminated.

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In order to present a clear edge, a manager must be willing to openly explain to investors

any changes in its portfolio risk.

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Managing Risk in Alternative Investment Strategies: Hedge Funds