With market volatility back, portfolios are swinging like piñatas, and the Dow Jones just closed more than 1,000 points higher. These market moves can be terrifying for some and many investors are asking “what’s next”?
As investors become increasingly nervous, behavioral finance teaches us this is when people are most vulnerable to emotionally-driven financial decisions. This behavioral bias is why investment professionals lead with data, educate their investor base and keep them informed in today's challenging market conditions. A new year coupled with increasingly volatile markets is a perfect occasion to answer “what’s next” and remind clients to manage and stay away from too much risk.
Communication is Key
After listening to hundreds of hedge fund and investor pitch presentations and working with some incredible investment managers, one thing that always makes a great portfolio manager stand out: they very clearly communicate their risk management expertise with their clients, and they do it often.
Here are some of the typical questions hedge fund risk managers ask themselves and share with investors:
- What percentage of assets are in any one strategy or financial product?
- How do we retest the investment thesis on core holdings?
- What monitoring takes place to expose deviations quickly?
- How often does the hedge fund risk management committee meet?
- Do drawdowns of any kind prompt investment committee review?
- How are exposures handled by issuer, industry, geography and asset class?
- Are risk metrics run daily or real-time on every position?
- What specifically are the risk alert triggers?
- How are positions stress tested?
- How are high-risk positions flagged?
- What is the maximum drawdown?
- How are credit, interest, and equity markets monitored?
- How is liquidity tracked?
- How are funds correlated and what happens when correlations rise between investments and asset classes?
- What checks and balances are in place to ensure adherence to portfolio risk limits?
- Is cash used as a risk management tool?
- How is leverage deployed?
- How are redemptions handled?
- Is there an active hedging process?
- What is the worst that can happen?
- What are the business continuity and offsite disaster recovery plans?
There are many other questions to consider when addressing hedge fund risk management with clients. This list is by no means exhaustive or a prerequisite to addressing risk with every client; it is intended to motivate meaningful conversations and communication. The manager that stands out because they put risk management first usually aims to protect investor principal at all times.