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: Few bets / concentrated themes and improper risk monitoring

Many people have a high tolerance to risk – as long as it pays…! Many investors still dream about asymmetric payout without costs.

A successful manager in a government-linked hedge fund had been adding tens of millions of dollars in a consistent ways for many years. While he had numerous bets in his portfolio, they were all based on his personal macro-economic views/themes. Thus the breadth of his strategy was relatively limited as all bets where really betting on his macro-economic forecast. As the risk department could not properly monitor his positions, he built them tools to monitor his own risk! In 2008, he lost some $1.2Billion, canceling many times the sum of all previous years’ value added. The loss was as large as the total alpha objective of the whole organization!

While concentrated bets may look sexy and is often sought by some people, the negative consequences can be very dramatic. Furthermore, this goes against all notions of optimal risk budgeting.

For more information on proper risk budgeting and how to better diversify one's source of returns and alphas, please contact us.

Dominic Clermont, ASA, MBA, CFA

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