The New Generation of Risk Management for Hedge Funds and Private Equity Investment

The New Generation of Risk Management for Hedge Funds and Private Equity Investments has been designed to address issues that raise disquiet among investors in alternative investments. Explore this relatively new area of risk management from investors' and participants' perspectives in hedge funds, private equity, fund of funds and mezzanine investments.

This book describes and evaluates the unique risks affecting individual hedge fund strategies, private equity investments and generic risks of types of alternative investment strategies. For those managing alternative investments, the perceptions of risk amongst their clients and potential clients that continue to affect the marketing of their skills are explained. Interest areas: AIS, alternative investments strategies, risk management, investment managment, portfolio management, venture capital, hedge fund strategies, hedge funds, private equity.

This book has been included as required reading for Level II of the Chartered Alternative Investment Analyst (CAIA) Association program. Chapters from this book have also been included as core reading in the new section on Risk and Investment Management in the GARP 2005 Financial Risk Management Exam.

The New Generation of Risk Management for Hedge Funds and Private Equity Investments has contributions by the leading names in the hedge fund and private equity universe. A private forum for you, the reader, with Mark Anson (CIO for CalPERS), Sir David Cooksey (Founder of Advent, Senior Director of the Bank of England, former Governor of the Wellcome Trust), Alexander M. Ineichen (Global Head of AIS research at UBS) and Leslie Rahl (founder of Capital Market Risk Advisors).

Contributors include:

Hans-Willem van Tuyll  *  Lars Jaeger  *  Alexander M. Ineichen  *  Patrik Säfvenblad  *  John St Hill  *  William Fung and David Hsieh  *  Sohail Jaffer  *  Leslie Rahl  *   William Feingold  *   Michael Pintar  *   Tolga Demir  *   Patrik Säfvenblad  *   Michael Rulle  *   Hilary Till and Joseph Eagleeye  *   André Frei and Michael Studer  *   Bradley Atkins and Mario Giannini  *   Martin Conder  *   Sir David Cooksey  *   William Schmidt  *   Mark Anson  *   Geoff Singleton  *   Alan H. Dorsey  *   Markus Schaub  *  Dr Franz Feldmann  *   Michael Romer, Michael Moise and Richard Hrvatin  *   Curt Burmeister, Helmut Mausser and Dan Rosen  *   Allan M. Malz  *   Pierre-Yves Moix  *   Paul Embrechts and Hansjörg Furrer  *   Peter Blum, Michel Dacorogna and Lars Jaeger  *   Achim Pütz  *   Simon Firth, Victoria Schonfeld and Isha Youhas  * 

Also by Lars Jaeger:

• Through the Alpha Smoke Screens: A Guide to Hedge Fund Return Sources, by Lars Jaeger (published 2005)
• Sources of systematic return in hedge funds chapter, by Lars Jaeger and Scott Higbee, Partners Group in Evaluating and Implementing Hedge Fund Strategies: The Experience of Managers and Investors, 3rd edition, edited by Ronald A Lake (published 2003)

 Also by Sohail Jaffer:

Virginia Parker, President and Founder, Parker Global Strategies, LLC 

Table of Contents

The New Generation of Risk Management for Hedge Funds and
Private Equity Investments

Contents
Author biographies
Foreword
Hans-Willem van Tuyll
Preface
Lars Jaeger

Chapter 1: Risks and risk management for hedge funds
Lars Jaeger
Challenges for the hedge fund industry
Sources of hedge fund return
Special challenges of hedge fund risk management
Risks in hedge funds
Elements of hedge fund risk management
Current issues for hedge fund risk management
Conclusion

Part I: Hedge fund risk

Chapter 2: Hedge fund risk
Alexander M. Ineichen
Introducing the absolute return approach
Risk management is supposed to yield asymmetric returns
Return illusion
Risk illusion from time diversification
Systematic risk versus non-systematic risk
Conclusion

Chapter 3: Understanding return sources of hedge funds and
private equity investments
Lars Jaeger and Patrik Säfvenblad
Summary
Introduction
The sources of hedge fund returns
The risk factor exposure of hedge funds and private equity
Active strategies and option-like returns
Modelling returns of active strategies
The role of manager skill
Lessons for investors
Conclusion

Chapter 4 : Measuring risk in hedge fund portfolios
John St Hill
Introduction
Strategy selection
Manager selection
Conclusion

Chapter 5: The risk in hedge fund strategies: alternative alphas and
alternative betas
William Fung and David Hsieh
Introduction
Peer-group-based style factors and return-based style factors
Asset-based style factors
Empirical results
Applications of ABS factors in portfolio and risk management
Conclusion

Chapter 6: Funds of hedge funds
Sohail Jaffer
Introduction
The set-up and value added of funds of hedge funds
Portfolio management strategies
Style risks and diversification: the selection of strategy sectors
Risks of fund of funds manager selection: the due diligence process
The post-investment risk management process for
multi-manager portfolios
Defining and managing hedge fund portfolio risk
The issue of transparency
Active risk management and the issue of liquidity
Conclusion

Chapter 7: Due diligence
Leslie Rahl
Know the context
Is the fund consistent with my goals?
The past
Information
Risk
Risk management
Risk management versus risk measurement
Risks
Compliance does not equal risk management
Conclusion

Chapter 8: Convertible arbitrage strategy
William Feingold
Introduction
How convertible arbitrage works
The risks
Conclusion

Chapter 9: Fixed income arbitrage
Michael Pintar
Introduction
Fixed income arbitrage strategies and their risks
Yield curve trades
Spread trades
Options trades
Portfolio risks

Chapter 10: Managing risks of long/short equity strategies
Tolga Demir
Introduction
Long/short equity
Short selling
Equity market neutral
Conclusion

Chapter 11: Global macro and managed futures strategies
Patrik Säfvenblad
Introduction
The sources of global macro returns
Systematic versus discretionary managers
Technical versus fundamental managers
Trend-following managers
Short-term trading
Fundamentals-based trading
Conclusion

Chapter 12: Trend following: performance, risk and
correlation characteristics
Michael Rulle
Introduction
Trend following and sources of return
Returns and volatility of returns
Correlation of returns and portfolio construction
Conclusion

Chapter 13: The risks of commodity investing
Hilary Till and Joseph Eagleeye
Risk and return sources of commodities
Role in a traditional portfolio: commodity futures investments
as a diversifier or return driver
Idiosyncratic risk and systematic macroeconomic risk factors
Conclusion

Part II: Private equity risk

Chapter 14: Quantitative private equity risk management
André Frei and Michael Studer
Introduction
Cash flow characteristics of private equity
Private equity risks and risk management
Conclusion

Chapter 15: Risk management for private equity funds of funds
Bradley Atkins and Mario Giannini
Introduction
Definition and role of a fund of funds
Structuring private equity funds of funds
Difficulties of measuring risk
Style risks and diversification
Risks of manager selection
Investment selection process
Monitoring portfolio risk
Active risk management
Conclusion

Chapter 16: The risks of mezzanine
Martin Conder
Introduction
What is mezzanine?
Reducing risk through credit analysis
The real value of mezzanine security
Portfolio returns: what you get in the long run
How the mezzanine portfolio manager reduces risk

Chapter 17: Risks of venture capital
Sir David Cooksey
Introduction
Background
The investment process
Assessing the general partner
Due diligence
The investor’s perspective

Chapter 18: Understanding and managing risk in leveraged buy-out
fund investing
William Schmidt
Introduction
Risks
Outlook

Part III: The perspective of investors, consultants and
third parties

Chapter 19: The fiduciary’s perspective on alternative assets and
institutional risk management
Mark Anson
Introduction
The concentrated portfolio
Do hedge funds hedge?
Fraud
Fiduciary risk management: establishing an investment policy
Conclusion

Chapter 20: A consultant’s perspective on hedge fund and private
equity risk
Geoff Singleton
Background
The strategic role for hedge funds and private equity
Implementing an allocation to private equity
Alternative strategies
Portfolio supervision
Fee structures
Cash flow management
Implementing an allocation to hedge funds
Scheme-centric framework: allowing for systematic risks and rewards
Financial economic case: where systematic risks and rewards
are excluded
Conclusion

Chapter 21: The perspective of consultants on hedge fund and private
equity risk
Alan H. Dorsey
Introduction
The evolution of AIS investing and risk management among
endowments and foundations
Organisational considerations for AIS risk tolerance
The role of the investment committee
The role of the investment staff
The role of a fund of funds
The role of the consultant
The first defence against AIS risk: diversification
Due diligence and AIS risk management
Summary

Chapter 22: Specific issues for pension funds and other
institutional investors
Markus Schaub
Introduction
Regulatory restrictions
Importance of risk management for institutional investors
Comparison with risk management in traditional asset classes
Risk measurement
Impact on risk-adjusted performance measurement
Strategic dimension
Conclusion

Chapter 23: Hedge funds: special issues for financial institutions
Dr Franz Feldmann
Introduction
The strategic production plan
Creating a white-label hedge fund of funds solution
Summary

Chapter 24: Hedge fund and private equity securitisation
Michael Romer, Michael Moise and Richard Hrvatin
Introduction
What is a securitisation?
Hedge fund CFOs
Why structure a CFO?
Private equity CFOs

Part IV: Risk management techniques

Chapter 25: Simulation-based risk management systems for
hedge funds
Curt Burmeister, Helmut Mausser and Dan Rosen
Introduction
Simulation and scenarios
Simulation-based methodology: Mark-to-Future
Simulation-based architecture
Scenario-generation methods
Modelling hedge funds and funds of funds
Examples
Case study: scenario-based risk management at Ritchie Capital

Chapter 26: Risk measurement for hedge funds
Allan M. Malz
The role of quantitative risk measurement in hedge funds
Market, credit and liquidity risk in hedge funds
Conclusion

Chapter 27: Style drifts: monitoring, detection and control
Pierre-Yves Moix
Introduction
On styles and strategies
Style drift: definition and importance
Main reasons for style drifts
How can a style drift be detected, monitored and controlled?
Conclusion

Chapter 28: VaR, stress testing and related risk management
techniques for hedge funds
Paul Embrechts and Hansjörg Furrer
Introduction
Value-at-Risk
Dependence in risk management
The use of VaR for hedge funds
Stress testing and scenario analysis
Conclusion

Chapter 29: Performance and risk measurement challenges for
hedge funds: empirical considerations
Peter Blum, Michel Dacorogna and Lars Jaeger
Risk and risk measures
Evaluation of risk measures
Risk in extreme situations
Dependence and diversification
Time dependence and volatility clustering
Conclusion

Part V: Legal and regulatory issues

Chapter 30: Legal and fiscal risks in structuring and selling hedge
funds in Germany 
Achim Pütz
Introduction
Current general legal conditions for hedge funds and structured
hedge fund products in Germany 
The Investment Act 2003

Chapter 31: Regulatory issues for hedge funds
Simon Firth, Victoria Schonfeld and Isha Youhas
Introduction
General issues
Issues and developments in the United Kingdom 
Issues and developments in the United States 
Issues and developments in the EU
Conclusion

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