Concentration risk arises because of increased exposure to one trading strategy or a group of correlated assets. Commonly, concentration risk is understood as exposure to a linked group of assets, for example, by location, by industry etc., while the actual correlation factor is ignored. When analyzing an individual hedge fund, concentration risk implies exposure to the underlying securities, while, for a FoHF, concentration refers to the strategy allocation. The primary reason to control concentration risk is to avoid an excessive correlation between assets or strategies. Therefore, a naive approach of addressing concentration risk by defining the strategy exposure limits is most questionable unless the underlying correlations are considered.
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