Hedge Fund Risk Fundamentals: Solving the Risk Management and Transparency Challenge

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John Wiley & Sons, Jul 1, 2007 - Business & Economics - 312 pages
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In the constantly evolving hedge fund marketplace, nothing is more central--but in many ways, more amorphous and elusive--than risk. Yet there remains no standard for analyzing and measuring risk within this highly secretive, largely unregulated field, leaving the thousands of hedge funds--and the tens of thousands of hedge fund investors--in dangerously dim light. The industry has not solved the "transparency" challenge--communicating risk to investors without disclosing proprietary information.

Hedge Fund Risk Fundamentals is the first book to bring these issues to the forefront. With clarity, concision, and minimal math, Richard Horwitz lays out the key components and the cutting-edge processes in the field of hedge fund risk management today. Against that backdrop, he presents a groundbreaking utility destined to set the standard for transparency and risk management within the hedge fund universe.

You’ll learn why, when it comes to risk management, 1 + 1 = 1.41. For all of those perplexed by the difficulties of assessing risk in hedge fund investing, Horwitz’s concepts make for an invaluable road map and a demystifying resource that hedge funds and investors at all levels will find indispensable.

 

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Contents

Volatility
11
Risks in Hedge Funds versus Traditional Investments
14
The Distribution of Hedge Fund Returns
20
Value at Risk VaR
23
Diversification
25
The Power of Diversification
26
Systematic Biases
31
Overdiversification
36
Definition of Risk Budgeting
128
A Management Process Not a BackOffice Tool
129
A Common Language
131
Managing Complex Causal Relationships
133
A Comprehensive and Integrated Approach
134
Integrated Systems Support the Process
136
Risk from the Investors Viewpoint
141
NAVReturn Reporting
143

Leverage
37
Financing Leverage
39
Notional Leverage
40
Unlevered Risk
44
What Is the Right Amount of Leverage?
45
Illiquidity
47
The Size Factor
49
The Cost of Illiquid Redemption Policies
51
Choosing among Alternatives
52
Market Risk Management
57
Measuring Risk
59
Normal Market Behavior
60
Will History Repeat?
61
Risk Measures Based on Actual Fund Returns
63
Risk Measures Based on Simulated Fund Returns
64
Crisis Market Behavior
68
Understanding the Source of Risk
71
IndexBased Benchmarks
72
Value at Risk VaR
73
RiskFactor Framework
74
Marginal Risk Measures
79
Risk Visualization and Articulation
83
Risk Visualization Techniques
85
Communicating Risk in HedgeSpeak
88
Risk Culture
91
Integrating Risk Management into All Hedge Fund Processes
92
Style Drift versus Nimbleness
93
Personality Risks
96
Other Risk Processes
99
NonMarket Risk Management
101
Systems and Procedures
104
Organizational Issues
105
Disciplined Processes
107
Constructing a Fund
109
Value Creation Levers
111
Shorting
113
Relative Misvaluations
115
Illiquid Securities
116
Leverage
117
Convexity
118
Nimbleness
119
Establishing a Basis in which to View the Construction
120
Balancing Risk and Return
121
Performance Attribution
123
Other Factors in Performance Attribution
125
Risk Budgeting
127
Inefficiencies
146
Incomplete Reporting
147
Misleading Measures
149
Masking Risk
150
Constructing a Portfolio of Funds
151
Integrating Asset Allocation Manager Selection and Portfolio Construction
152
Understand Manager Risks
154
Adopt a Prospective Outlook
155
Minimize Exposure to the Underlying Market
156
Limit Offsetting Exposures
157
Plan for the Worst
158
Risk Due Diligence
159
Analyzing Previous Portfolios
160
Determining Transparency and Risk Culture
162
Transparency
167
The Political Environment
170
The Pros and Cons of Position Disclosure
175
The Solution
177
Industry Standard Solution
179
Reporting StandardsA Common Language
181
The Risk Fundamentals Solution
185
NAVReturn Reporting
186
The Risk Fundamentals System
187
The Risk Fundamentals Statistics
188
Distributed Solution
191
Standardization with Flexibility
192
Risk Budgeting Support
194
Effective Risk Communication
195
Interpreting Risk Management Reporting
197
Concentrations
199
Leverage
209
Liquidity
211
Risk Factors
217
Historical Simulation
224
Stress Tests
228
Convexity
230
RiskReturn Analyses
231
Constructing a Fund
232
Constructing a Portfolio of Funds
238
Performance Attribution
244
Summary
249
Integrating Market Correlation into RiskAdjusted Return
253
Glossary
261
Index
269
CFP Board CE Requirement
277
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About the author (2007)

Richard Horwitz is managing director of manager assessment and risk management of Merrill Lynch's Hedge Fund Development and Management Group (HFDMG). He has implemented Risk Fundamentals, a proprietary risk transparency and management system. The system is risk factor based, permitting underlying funds to provide structural risk transparency without requiring position disclosure and for this transparency to be used to provide a fundamental understanding of each underlying fund and to construct risk-efficient portfolios of funds. Previously, Horwitz was senior vice president and director of risk management and investment analytics at Kenmar Global Investment Management Inc., a $2 billion fund of funds. He gained his fundamental knowledge of hedge funds as a principal at Capital Market Risk Advisors, Inc., the boutique risk management consulting firm. Horwitz had previously been a buy-side senior equity analyst at Sanford C. Bernstein & Co. and a consultant in financial services at Booz Allen Hamilton Inc. He earned an MS in management (Sloan School) and a BS in electrical engineering from the Massachusetts Institute of Technology. Horwitz has also written numerous articles on hedge funds.

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