Hedge funds & the 5 major hurdles to effective risk management
Sound risk management. Is there anything more important for a hedge fund these days? Arguably not … especially if you want to achieve sustainable outperformance for the long term, and continue to attract and retain assets and investors.
Hurdles to Managing Risk
With traditional fee models under pressure, investors increasingly intolerant of disappointing performance and the industry facing growing regulatory scrutiny, enhanced risk management practices have become a competitive necessity.
But as we’ve all seen, monitoring and managing the myriad investment and operational risks firms must grapple with each day is no easy task. In particular, funds must find a way to deal efficiently with the following five major challenges:
1. Finding and reporting on firm-wide positions across asset classes
Portfolio managers’ tendency to work independently, combined with functionally-limited and non-integrated IT systems often results in asset class silos. That makes it hard to obtain an up-to-date, enterprise-wide picture of your exposures and track the firm’s aggregated risk position.
2. Evaluating and quantifying counterparty risk
With trading speed constantly accelerating, evaluating the risk counterparties pose at any given moment becomes a monumental undertaking. The proliferation of counterparty relationships exacerbates the challenge.
3. Reconciling data from multiple counterparties
Getting accurate and timely data from all those trading counterparties and back-office service providers is no small feat. That data must then be reconciled, and any resulting discrepancies rectified. It’s often mundane and time-consuming work, but crucial nonetheless.
4. Accessing real-time risk and exposure reporting
Data needs to flow seamlessly from manager to vendor and counterparties and back, to close any gaps between trading, risk and reporting. However, real-time data feeds, trade information and position monitoring are not always available, especially when dealing in emerging markets.
5. Valuing illiquid securities and portfolios
Determining the fair value of an infrequently traded, custom-built OTC derivative or complex loan product can be problematic, to say the least. Not only that but because illiquid securities are less frequently priced, valuations may smooth reported returns, causing their volatility and the risk they pose to be underestimated.
Technology can play a central role in helping hedge funds navigate these hurdles. A robust risk management framework built on an integrated technology infrastructure, and supported by rigorous processes and procedures, is key to enabling a variety of best practices, including:
- Enterprise-wide data mining to produce a consolidated risk view in real time.
- Monitoring of portfolio manager thresholds and fund concentration limits to guard against excessive exposures.
- Intra-day VaR capabilities to inform portfolio decision making.
- Real-time reporting for all assets by strategy, portfolio, counterparty, creditworthiness or firm-wide position.
With effective risk management so crucial to hedge funds’ continued success, can you afford anything less?
For more information, read our whitepaper at Managing Risk in a New World.
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