Hedge funds: Five major hurdles to effective risk management

By: Marius Esterhuysen

Sound risk management: is there anything more important for a hedge fund these days? Arguably not, especially if you want to achieve long-term, sustainable outperformance and continue to attract and retain assets and investors.

Hurdles to managing risk

With traditional fee models under pressure, investors intolerant of disappointing performance, and growing regulatory scrutiny, enhanced risk management practices are competitive necessities.

But monitoring and managing the myriad investment and operational risks faced by firms every day is no easy task.

To succeed, funds must overcome the following five 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, which makes it hard to obtain an up-to-date, enterprise-wide picture of exposures and track a 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 difficult. The proliferation of counterparty relationships exacerbates the challenge.
  3. Reconciling data from multiple counterparties
    It’s difficult to get accurate and timely data from all those trading counterparties and back-office service providers. That data must then be reconciled, and any resulting discrepancies rectified.
  4. Accessing real-time risk and exposure reporting
    Data must 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. In addition, because illiquid securities are less frequently priced, valuations may smooth reported returns, causing their volatility and the risk they pose to be underestimated.

The answer

Technology helps hedge funds navigate these hurdles. A robust risk management framework built on an integrated technology infrastructure and supported by rigorous processes and procedures enables 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

To learn how we can help you navigate these and other hurdles, contact us at 800-234-0556 or solution@sscinc.com.