By Bruce Frumerman & Samuel K. Won
(Excerpted from an article co-authored by Sam Won)
As Global Risk Management Advisors counsels, there are four sets of portfolio management-related risk management questions that prospective investors delve into that hedge fund firm owners should ask themselves to give their businesses a quick self-assessment.
1. Risk Management Governance
Can the fund show it has a formal risk management committee composed of senior members of the front and middle office that is responsible for monitoring investment risks, developing and overseeing the firm’s risk management guidelines and serving as the overarching governing body for risk management?
2. Risk Management Processes and Controls
Can the fund communicate formal risk management processes that are cohesive and integrated with the investment process? Specifically, can it explain how its integrated process is sound, repeatable and sustainable? Can the hedge fund demonstrate how its risk management protocols are helping to identify alpha producing investment opportunities, properly “risk-size” positions, and take necessary defeasance measures, if needed, should an investment not pan out as expected?
3. Risk Management Transparency and Reporting
Can the fund provide all of the necessary risk statistics and analysis that is required to attract and retain institutional investors? For example, can the hedge fund provide prospective investors with information such as risk and performance attribution, alpha calculation, volatility, beta/delta-adjusted exposures and correlation data?
4. DDQ and Fund Marketing Materials
Do the current Due Diligence Questionnaire answers and marketing collateral meet today’s institutional quality litmus test by clearly describing and delineating how the hedge fund measures, monitors and manages its investment risks as well as the risk management processes, controls and governance that it has in place as the pillars of its overall risk management framework?
Not only do hedge funds need to be able to answer these questions, they need to be able to provide supporting documentation to demonstrate the veracity of their claims. Hyperbole will not cut it. Further, given today’s risk related regulatory requirements, hyperbole could trigger regulatory examination or enforcement action.
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