Risk Management and Hedge Funds
What do hedge funds do? This is indeed a vexing question and the laymen answer would be that they make a h'll a lot of money. More generally and professionally there are whole courses devoted to the subject at various business schools around the world and although I am training as a macroeconomist I am attending courses at a business school where I have on several occasions talked and socialized with future hedgies (in spe :)) living in a mad short term world which is quite fascinating I have to say. So if I, as a macroeconomist, should describe with few words what hedge funds do, well risk management of course :).
Felix Salmon over at RGE churns out so many posts a day that I am sometimes hard pressed to keep up. Consequently, I had to scroll down through quite a few entries to find the main source for this entry. As such, Felix noted yesterday a report from Deloitte (PDF) which examines the risk management and valuation practices in the global hedge fund industry. I am not very much into this subject so I can't comment with much force but generally I have to side with Felix in his articulation of some of his worries. Especially, I also take note that a whopping 50% of hedge funds don't track what is coined as embedded leverage in assets such as forwards, futures, and derivaties. I am obviously, like Felix I suppose, pretty surprised since this asset class is what hedge funds particularly specialize in as such you should think that the risk management efforts to be particularly sound here. Moreover, the very characteristic of this asset class is risk and more importantly how to hedge against risk in these markets. Quite simply, it is very weird that so many hedge funds do not track the embedded leverage which after all is a pretty good proxy for overall risk.
As I said, this is clearly not my area of expertise but still some of these numbers from Deloitte seems quite surprising relative to the general perception I had of the industry as essentially an outsider.