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Hedge Fund Risk Fundamentals

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Hedge Fund Risk Fundamentals

Solving the Risk Management and Transparency Challenge

Bloomberg Press,

15 min read
10 take-aways
Audio & text

What's inside?

Would the returns of a hedge fund investment balance the risks? Here’s how to weigh the chances (caution: danger ahead).

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Editorial Rating

8

Qualities

  • Innovative
  • Applicable

Recommendation

Hedge funds are complex, risky investment vehicles. Other funds, such as most equity mutual funds, have straightforward investment strategies. By contrast, equity-oriented hedge funds may engage in various trading practices and investment strategies. They may be short funds, long-short funds or market neutral funds. And equity-oriented hedge funds are only a small sliver of the hedge fund universe. Thus, assessing the risk of hedge funds is a challenge. In language intelligible to most lay readers, author Richard Horwitz lays out the issues to consider when evaluating hedge fund risks. He has accomplished a great deal merely by writing this in readable prose, instead of in equations. He also explains his company’s hedge fund risk measurement system. getAbstract believes every hedge fund manager and anyone who even thinks of investing in a hedge fund should read this book.

Summary

Acknowledge Volatility

Volatility is the result of uncertainty. Uncertainty and risk are closely related. Risk is, in fact, the variability of returns around a fixed reference point. An investor might be willing to pay $10 this month to receive a sure and certain $11 next month. The same investor would be less willing to pay $10 if next month’s receipt might be $11, but might equally be only $6.

In general, the greater the risk, the greater the return the investor demands. Prices of investment opportunities fluctuate as investors receive new information that causes them to change the way they think about possible returns.

For example, if an oil organization announces that it has found a major new reserve, or if a pharmaceutical organization announces a breakthrough drug, those organizations’ economic prospects become much more attractive and their stock prices rise. Similarly, if a nation installs a government that implements a credible plan of financial discipline, investors smile, the risk of investing in the country’s bonds falls and, therefore, the bond price rises.

Efficient market theory says that investors quickly factor new information into the ...

About the Author

Richard Horwitz is senior vice president and director of risk management and performance analytics at Kenmar Global Investment Management Inc., a fund of hedge funds located in Greenwich, Connecticut, and a frequent contributor to Risk magazine.

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