Hedge Fund Due Diligence

Most Hedge Fund scandals would be avoided with proper due diligence performed by experienced managers.


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April 19, 2012: Death of a great investment counselor, Carl H. Otto

Updated: April 20, 2012

Due Diligence: Improper asymmetric risk controls

A young NY based hedge fund was long stocks with positive alpha, and short the S&P 500 index. Its risk controls included not having bets larger than 1% - leading to small specific risk. Yet, they once experienced a significant bad performance due to some asymmetric specific risk. While they could not own more than 1% in any one name, they could short 3% of the largest companies through their short index position. In markets outside the US where single stocks could have weights much greater than 3%, the specific risk taken in the shorts could be significantly greater. While this asymmetry was later corrected, it showed the lack of experience of the hedge fund manager, and the lack of experience of fund of funds who invested in that strategy and were surprised by the loss experienced on the short side due to one large stock.

For more information on proper risk controls integrated to the portfolio construction process, please contact us.

Dominic Clermont, ASA, MBA, CFA

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