Incompetence … and Incompetence Again Print E-mail
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Incompetence … and Incompetence Again
Incompetence (contd.)
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The unique hedge fund risk management problems deriving from the numerous factors like non-normality of their distributions of returns, bizarre hedge fund indices and the data biases are not new. One may easily find hundreds of articles and deep researches on the subject as well as a few proven frameworks offering feasible solutions by enhancing the commonly used risk metrics. While these frameworks may vary in the suggested models and their implementation, they all have one thing in common: the mean-variance risk valuation methodology is hardly applicable to hedge funds and, to an even greater extent, to fund-of-funds instruments.
Still, it does not seem these voices are being heard by the financial institutions. According to our statistics based on the real contacts with hundreds of investment managers, over 85% of the total number of one hundred and fifty six recipients still widely use the classic mean/standard deviation metrics for the hedge fund risk assessment combined with the “proven” Tactical Asset Allocation as a way of constructing hedge fund portfolios.
Surprisingly, no one has ever been really arguing the clear facts of inapplicability of the currently used frameworks. You may ask then, why not to incorporate something more advanced and appropriate. Well, among many given excuses, there are a few most typical and funny ones:
  • “our senior management will not understand this”;
  • “it would take years to approve a new framework”;
  • “we are not sure, if we need it at all… we are investing into real estate funds” - this wise statement was done, obviously, before collapsing the real estate market;
  • “we do not need a new quantitative framework; our investment process is based on knowing-our-managers due diligence, so we know what to expect from them.”
What is really needed for these people to learn something? A new LTCM? A new Enron? A global meltdown? Almost every month we are witnessing a new institutional fund collapse case. It has become a common habit to blame the subprime crisis for everything, for all the losses and defaults.