Both banks and hedge funds recognise the management of risk as a central business imperative. At a high level, all firms that manage financial assets share a key objective of risk management: to better structure a portfolio of trading securities and/or investment positions to minimise risk taken relative to return obtained. Major sub-objectives are also similar, such as providing analytics that make the nature and size of the main risks embedded in the portfolio reasonably transparent. Also, at both banks and hedge funds, risk management principles and practices have become more formal and quantitative over time – adding elements of “science” while retaining key aspects of “art”. However, hedge funds face significantly different business histories and challenges than banks – and that drives differences in how risk management contributes to business success for these two types of firms.
Just as the practice of financial risk management spread many years ago from proprietary bank trading desks, to hedge funds and other asset managers and then to institutional investors such as pensions, endowments and foundations, today it is spreading to family offices and high-net-worth investors and has even begun to enter the retail space. While the uses and practices of risk management differ in and among each of those investor types, they all have lessons to offer the others: banks should provide more risk transparency to investors and hedge funds would do well to adopt a more formal risk management program. As global regulators increasingly view banks and hedge funds with more scrutiny, they could both benefit by learning from each other.
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