Hedge funds still changing the way they look at risk

Hedge-fund managers are prioritizing risk management like never before. Before the 2008 meltdown, portfolio managers used risk management to satisfy institutional investors' due-diligence requirements. Some managers were less averse to risk than others, but generally speaking risk management wasn't a top-line issue for hedge funds.
Now, as investors clamor for more transparency, risk management has become an across-the-board phenomenon. The position of chief risk officer, once an anomaly at hedge funds, has become common.

"People are realizing risk is not just a simplistic solution," said Jayesh A. Punater, founder of IT and risk management technology provider Gravitas Technology, which does work mainly for alternative-investment companies.

After performance, investors list risk management as the most important consideration in investing in a hedge fund, according to several recent surveys. Some managers are banking more and more on those two factors being tied together.
"If you can possibly put a positive spin" on last year's events, "there is a lot more data on tail events," said Jonahtan Hudacko, executive director of MSCI Barra's portfolio analytics group.

The devastating tail events – a phrase for the "tail" in a distribution curve that depicts extreme events - from last September and October, Hudacko said, have left investment teams scrambling to create new trading strategies from the data.

"You get another set of users looking for an investment opportunity within the risks themselves," Hudacko said. While not unheard of before, he said it's certainly become more common, especially among quantitative managers. And hedge-fund companies are being very proprietary about how they're using the risk services.

"You find information being used by a lot more people," Hudacko added. Before, he said, it was maybe one analyst watching risk levels. Now, more hedge-fund managers are having daily meetings dedicated solely to risk.

Ken Tropin, who runs global macro hedge fund Graham Capital, is one manager who actually had a success in all of his strategies last year. He attributes some of that to his focus on risk management. In an interview, he said that for the last 18 months he has run a risk-management meeting first thing in the morning. At these meetings, Graham focuses on market liquidity, counterparty risk and every trader's individual risk profile as well as the aggregate risk of all of Graham's positions.

It's impossible to know whether other hedge funds would have faired better with daily risk meetings, especially considering that previously accepted measures of risk aren't so acceptable anymore.

The commonly used "value at risk" basically measures the best possible outcome on the worst day, but the lesson of 2008 was that a bad day could get worse, and quickly. VAR is still useful in some ways - there aren't many "worst" days in a given time period - but forcing hedge-fund managers to report their VAR might not help.

In the European Union, hedge funds with retail clients have since 2007 had to calculate for regulators a daily VAR. That didn't stop performance losses for most funds, and VAR never accurately measured risk for funds exposed to Bernard Madoff.
So for the service providers like MSCI Barra, the solution has been to create new measures that capture more extreme risk.

More and more, said Hudacko of MSCI, hedge-fund managers are saying, "If VAR is the best thing that could happen to me on the worst day, tell me the most likely thing that can happen to me on the worst day.

-Dow Jones Newswires