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Seminars

Hedge Fund Risk Management

Date: 03-24-2008
Start Time: 6:00pm
End Time: 7:30pm
Speaker: Aaron Brown, AQR Capital Management
Location: 412 Schapiro CEPSR, Davis Auditorium

ABSTRACT

When Alfred Winslow Jones opened the first hedge fund in 1949, risk management was only an issue between the portfolio manager and investors. That continued to be true for the next 49 years. Most funds embedded some sort of qualitative or quantitative market risk targeting in their strategies, but risk management was not distinguished from portfolio management, and was usually a part-time responsibility.

The collapse of Long-Term Capital Management in 1998 alerted people to the growth in hedge funds and their potential to affect markets and regulated financial institutions. Over the next few years hedge funds won increasing shares of pension and endowment funds, and were marketed to less wealthy and sophisticated investors. Some of the more successful funds grew into diversified asset management companies, some even raised public capital, and many regulated financial institutions developed or bought hedge funds. All of this created a strong demand for full-time professional hedge fund risk managers.

This talk will begin with a discussion of the causes of hedge fund failures and lead into the distinction between fund risk and management entity risk. For many hedge fund strategies, fund risk is kept quite high, exploiting the ability of the fund to accept market, liquidity and leverage risks beyond the limits of public mutual funds and other regulated investment managers. These risks are still negotiated between portfolio manager and investor, although that discussion has become more sophisticated with distinctions among alpha (portable or not), beta (exotic or vanilla) and other parameters. Another complexity-increasing factor is the growth of intermediaries, particularly fund-of-funds, between hedge fund and investor.

The management entity, on the other hand, generally wants low exposures to enterprise, credit and operational risk (except credit risk explicitly chosen by portfolio managers holding credit-sensitive positions). This is also in the interests of regulators, counterparties, prime brokers, capital providers and fund employees.

The talk will conclude with examples of the specific quantitative risk measures needed to meet the diverse requirements of a modern hedge fund.

BIO

Aaron Brown is risk manager at AQR Capital Management, author of The Poker Face of Wall Street (Wiley, selected as one of the best books of 2006 by Business Week) and co-author of the forthcoming A World of Chance: Betting on Religion, Games and Wall Street (Cambridge University Press, 2008). In his 25 year Wall Street career he has been a trader, portfolio manager, head of mortgage securities and risk manager for Morgan Stanley, Citigroup and other major firms, and has been a finance professor. He was selected Financial Educator of the Year by the readers of Wilmott Magazine and his website won the Forbes Best of the Web award for Theory and Practice of Investing. He serves on the Global Association of Risk Professionals editorial board and is a member of the National Book Critics Circle. He holds degrees in Applied Mathematics from Harvard and Finance from the University of Chicago.