Book Review: Global Association Of Risk Professionals

Richard Horwitz’s new book provides a clear primer for understanding hedge fund risk. While Hedge Fund Risk Fundamentals refrains from using any formulas, the book is a must-read for every risk professional who wants to see how complex risk issues can be explained in a non-technical way.

The book begins with basics that most risk professionals will be all too familiar with, but Horwitz’s explanation of risk concepts in a clear and intuitive way provides a good example for risk managers who need to be able to explain risk in understandable terms to colleagues and clients. Beyond the clear explanations, the book also identifies what risks hedge funds take and explains what investors in hedge funds should be looking for as sources of risk and return.

Transparency is one of the most overused words in the hedge fund business today. However, as Horwitz notes, there is no question that hedge funds, up until recently, operated in a “trust me” world. Operations were small, quiet and low profile, and portfolio managers rarely talked about their funds with anyone outside of investors in a specific fund. Therefore, it was quite difficult to obtain specific information about the composition of various funds.

But the Long-Term Capital Management debacle changed everything. In 1998, LTCM’s losses exploded onto the front pages of newspapers, just as institutional interest in hedge funds was beginning to grow. Major brokerages lost millions, because they did not understand the risks LTCM took with the money they loaned the firm.

Rather than shuttering the otherwise highly profitable business of lending to hedge funds, brokers started asking fund managers – sometimes on a daily basis – about what was in a specific fund and what were the risks? The hedge funds that needed leverage to prosper were forced to comply. Why the fuss over transparency? Well, one reason is that fund managers traditionally worry about the “short squeeze.” They fear when the market knows they are short, it will call in the stock and run up the price of stock sold short – and a short sale has unlimited loss potential.

But that is not the only reason why hedge fund managers have in the past been reluctant to divulge details about their funds. These managers have also expressed concern that investors will reverse engineer their investment process, if they can see how the managers are trading. This concern stems from the fact that investors in funds are often competing hedge fund managers that have the ability to reverse engineer strategies.

For these reasons and more, hedge funds are reluctant to share their positions with any investor.

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