Hedge Fund 101 (5)

by Hedge Fund July. 27,2023
Hedge Fund 101 (5)


Investing in hedge funds can increase portfolio diversity, which allows investors to reduce the overall risk exposure of their portfolios. Hedge fund managers use specific trading strategies and instruments in order to reduce market risk and obtain risk-adjusted returns, as opposed to the Investors expect the same level of risk. The ideal hedge fund would earn a return that is relatively independent of the market index.

Although "hedging" is a means of reducing investment risk, hedge funds, like all other investments, cannot avoid it completely. Risk. According to a report published by the Hennessee Group, between 1993 and 2000, hedge funds' The degree of volatility is only about 2/3 of the S&P 500 over the same period.

Risk Management

Most countries require that investors in hedge funds be sophisticated and qualified investors, should be aware of the risks of investing, and are willing to take these risks because of the potential rewards associated with the risk. To protect capital and investors, fund managers can employ a variety of risk management strategies. According to the Financial Times, "Large hedge funds have some of the asset management industry's most sophisticated and the most accurate risk management measures." A hedge fund management company may hold a large number of short-term positions and may also have a particularly comprehensive risk management system in place.

The fund may have a "risk officer" responsible for risk assessment and management, but not for trading, or it may take such measures as a formal portfolio management system. Strategies such as risk models. Various measurement techniques and models can be used to calculate the risk of hedge fund activities; depending on the size of the fund and the investment strategy, the fund The manager will use a different model. Traditional risk measures do not necessarily take into account factors such as the normality of returns. In order to consider the full range of risks, the use of value at risk (VaR) can be compensated for by including models such as impairment and "time to loss". to measure risk deficiencies.

In addition to assessing the market-related risks of an investment, investors may also assess, based on prudent business principles, the potential impact of a hedge fund's failure or fraud on the The risk of loss to investors. Consideration should be given to the organization and management of the business by the hedge fund management company, the sustainability of the investment strategy and the development of the fund's financial position. Company Capacity.

Transparency and regulatory matters

Because hedge funds are private funds, there are few public disclosure requirements and some argue that they are not transparent enough. Many others believe that hedge fund management companies are less regulated and have lower registration requirements than other financial investment management companies Moreover, hedge funds are more vulnerable to specific manager-induced risks, such as deviations from investment objectives, operational errors and fraud.

In 2010, newly proposed regulations in the United States and the European Union required hedge fund management companies to disclose more information and increase transparency. In addition, investors, particularly institutional investors, have contributed to further hedge fund improvements through internal controls and external regulation Risk Management. As the influence of institutional investors grows by the day, hedge funds are becoming increasingly transparent, publishing more and more information, including valuation methods, the Positions and leverage, etc.

Same risks as other investments

Hedge funds have many of the same risks as other investments, including liquidity risk and management risk. Liquidity refers to the ease with which an asset can be bought, sold, or liquidated; similar to private equity funds, hedge funds have closed periods. Investors cannot redeem during this period. Management risk refers to the risks arising from the management of a fund. Management risks include: hedge fund-specific risks such as deviation from investment objectives, valuation risk, capacity risk, concentration risk and leverage. Risk. Valuation risk refers to the possibility that the net asset value of an investment may be miscalculated.

Excessive exposure to a particular strategy, which creates capacity risk. Concentration risk arises when a fund has too much exposure to a particular investment product, sector, strategy or other related fund. These risks can be managed by controlling conflicts of interest, limiting fund allocations and setting ranges of strategy exposures.

Many investment funds use leverage, which is the practice of borrowing money to trade beyond the investor's contribution or using margin trading. While leverage can increase potential returns, it can also magnify losses. Hedge funds that use leverage may use a variety of risk management techniques. Hedge funds are less leveraged than investment banks; according to a working paper by the National Bureau of Economic Research, the average investment bank is 14.2 times leverage, compared to 1.5 to 2.5 times for hedge funds.

It has been argued that certain funds, such as hedge funds, in order to maximize returns within a risk range that investors and managers can tolerate, will Greater preference for risk. If the manager himself invests in the fund, there is more incentive to increase the level of risk regulation.