| February 01, 2008 | -- Hedge Funds and Operational Risk
Article from OpRisk & Compliance, by Victoria Pennington
(The following is extracted from the above article.)
LONDON, February 2008 (OpRisk & Compliance) -- Although the market is very fragmented, hedge funds face many of the same operational risks as more traditional asset managers. The extent to which they are exposed to certain risks, however, depends on the size of the organisation. Smaller hedge funds are more prone to mis-valuations and fraud-related problems, or problems in their service provider network; while the larger funds have more complex problems such as difficulties valuing illiquid instruments, selling processes, or more general problems relating to transparency or illiquidity in their portfolios.
Valuation risk is often flagged as the biggest issue because many funds have blown up due to intentional or unintentional mis-valuations of portfolios. Good governance practices ensuring segregation of duties are high on the list.
Mike Rasmussen, chief operating officer of Capricorn Asset Management, outlines the importance of employing a COO to ensure this. "It is important that a hedge fund has a chief operations officer whose dedicated function is to address all operational issues of the hedge fund. The trading manager should be responsible for producing alpha, not the day-to-day running of the business. Having a dedicated and experienced COO is a strong start for a hedge fund but many start-ups tend to overlook it as an unnecessary cost."
In the recent Ernst & Young survey, retaining key staff was considered to be the top operational risk faced by hedge funds, and people and governance issues are covered in detail in the HFWG op risk standards. The importance of adequate training in operational procedures and remuneration is also highlighted. "There is a disconnect between how traders are compensated - they are rewarded for how much money they make but this is often unrelated to how much risk they take on. When funds blow up, traders responsible have often already been paid their multimillion-dollar bonuses regardless of the subsequent fallout from their actions. This can be picked up using scenarios and stress testing," says Algorithmic's Cagan.
-By Victoria Pennington, OpRisk & Compliance; +44 (0) 207 004 7508; Victoria.Pennington@incisivemedia.com
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Capricorn is an established currency manager with a global client base that includes; Banks, Asset Allocators, Institutions, Investment Funds and High Net Worth Individuals. As of today, the company has more than 50 years of experience within the investment advisory arena, and manages over US$70 million in client assets. For the last eight years Capricorn has produced superior risk adjusted returns in its investment programs, trading high liquid currencies as managed accounts and offshore funds for Individual and Institutional clients. The vision behind Capricorn is to reach our capacity of US$ 500 million, managing the assets of professional investors. To achieve this goal our aim is to provide premium investment programs that seeks, strong returns with low volatility and a low correlation to other investment vehicles. In order to strengthen our ability to add value to our clients’ portfolio, we choose to develop and maintain relationships with reputable financial institutions that are leaders in their field.
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