Posted: May 25th, 2022

Risk Management in Hedge Funds Dissertation

Risk Management in Hedge Funds

A research of how dissimilar hedge fund managers identify and achieve risk

The most vital lesson in expressions of Hedge Fund Management comes from the inadequate name of this kind of alternative investment that is an alternative: The notion that all methodical risks are differentiated away is not really applicable here, with the Hedge Fund returns, in realism, representing a mixture of superior administration of market inadequacies and cognizant contact to some exact systematic risks. Simply the methodical risks that are “unwanted” from a strategic standpoint are expanded away. So, hedge funds, in actual fact, are not completely hedged.

Furthermore, the right measure that is in expressions of risk management contact moves from the jurisdiction of additional risk in contrast to a standard to a total risk method. Having the total return here is what really matters for administrators and depositors and not a contrast of the hedge fund presentation to some benchmark, like in other forms of funds.

Likewise, the undesirable skewness that is related to a lot of class of hedge funds provide a vital challenge to quantitative methodologies that are based on the supposition of returns familiarity (e.g. Riskmetrics classic method), with the area turning into a very good study case for new methods, like Extreme Value Theory (EVT).

Finally, with this multifaceted outline in mind, the need for an first and continuous due assiduousness and decision-making tracking flows as the most important concern from an investor’s or fund of funds’ viewpoint. At this time, the duty of full portfolio clearness (for genuine stockholders, but not for the entire market) becomes obligatory for the positive risk manager, while, obviously. other kinds of risk usually non-spoken through quantitative methodologies, (e.g. The liquidness barriers recognized through long “lock-up” periods) can not also be undervalued.

Table of Contents

Acknowledgement 1

Abstract 2

Chapter One 5

General Introduction 5

1.1 Background 7

1.2 Problem discussion 12

1.3 Purpose 13

1.4 Problem definition 13

1.4 Limitations 13

1.5 Perspective & #8230;.14

Chapter Two: Literature Review 16

2.1 Fee Structures 18

2.2 Varied Variability 20

2.3 Valuation Issue & #8230;28

Chapter Three: Methodology 31

3.1 Research philosophy 32

3.2 Research strategies & #8230;33

3.3 Research method & #8230;34

3.4 Method of data collection & #8230;34

3.5 Primary and secondary data 34

3.6 Qualitative and quantitative method 35

3.7 Interview 36

3.8 Interviewee selection 38

3.9 The questionnaire 39

3.10 Primary data analysis 42

3.11 The credibility of the study 43

3.12 Working approach & #8230;43

3.13 Reliability and validity & #8230;44

Chapter Four: Interviews and Analysis 47

Inroduction & #8230;47

4.2 The definition and nature of risk 49

4.2.2 The justification of risk management 51

4.2.3 The utilized risk management strategies 52

4,2.4 The difference among the measurement and the management of risk 54

4.2.5 The management of risk in the construction process 55

4.2.6 The risk variables used 55

Chapter Five: Finding and Recommendation 57

5.1 The definition and nature of risk Analysis 58

5.2 The justification of risk management 58

5.3 The utilized risk management strategies & #8230;59

5.4 The difference among the measurement and the management of risk 59

5.5 The management of risk in the construction process 60

5.6 The risk variables used 61

Chapter Six: Conclusion 63

References 68

Appendix 77

INTRODUCTION: CHAPTER ONE

A hedge fund is basically looked at as a private investment fund that is insecurely controlled, skillfully achieved, and not extensively obtainable to the public (Lhabitant, 2004). Rendering to an approximation of the Van Hedge Fund Advisors, the hedge fund is an industry that has been in the process of growing at an all time rate of 15% per annum that as been over the last era and is certainly projected to endure at this important degree. There were about 7,000 hedge funds that are functioning in 2009 with a total assets that have a value of USD 1.5 trillion. The rising approval of hedge funds has produced study whether hedge fund administrators can actually create greater presentation. Assessing hedge fund managers’ abilities is a thought-provoking task for a lot of different reasons.

First, material on hedge funds is problematic to get. Unlike funds that are mutual, hedge funds are not a requisite when it comes to reporting to an industry connotation. They willingly report a lot of the data to numerous databases. Therefore, the information is not complete, and the return data is dependent on a number of prejudices.

Hedge fund is a word that has continuously been related with much disagreement. In the stir of remarkable failures for instance the two Bear Stearns which are linked hedge funds, which made the corporation’s third quarter net-profit deterioration by roughly 65% due to losses incurred by the hedge funds, many questioned the strategies and the risk management which has been employed by hedge funds (Grynbaum, 2007). Computing and understanding the risk characteristics that are associated with the forms of investments and the positions which are faced by hedge funds is very complex, combine this with the typical lack of transparency and data regarding the hedge fund and the subject gets even more complicated. This is what led many stockholders to take legal actions that went against a lot of the protuberant hedge funds that were involved in the sub-prime mortgage situation; the thinking was that the hedge funds were unsuccessful to notify the stockholders of the risks that were associated with the savings that the funds had assumed (Graybow, 2007).

Figure 1: Top Hedge Fund Companies

Hedge funds are a relatively new financial vehicle in some countries and its popularity is growing quickly (Anderlind, Dotevall, Eidolf & Sommerlau, 2003). The regulations in places like England appear to be much stricter regarding the operation of the hedge funds than in USA, but freedom for the managers and a complicated risk characteristic are still noteworthy sections of the domestic hedge funds (Aronsson, 2006). observing as the hedge funds have been known to have an access to a much larger market and can also have the right to trade in different forms of financial devices, derivatives and merchandises, the approaches obtainable to the administrators are apparently limitless. With this, there have been a lot of different kinds of risks that have also been born, as well as approaches to counter them (Reuters, 2011). As risk management is a vital portion of handling a reserve and bearing in mind the complexity of the jeopardies confronted by hedge funds, this is a thought-provoking topic to study. We have therefore made the decision to study the risk management used in hedge funds, how the fund managers’ build their portfolio when it comes to the validity and the risk of diverse risk measures utilized to compute the risk.

1.1 Background

The founder of the first hedge fund was Alfred Winslow Jones. He was born in Australia 1901 but then moved, yet young, to the United States where he started his education (McWhinney, 2010). He then pursued and graduated from Harvard at the age of 22 and then became an American representative in his early thirties. Jones then went on to get his PhD from the University of Columbia and in the timely 1940s he began working a job for the Fortune magazine (McWhinney, 2010). During the time Jones was writing an article concerning the tendencies of new replacements for capitalizing capital for the periodical in 1948, he started become interested in trying to manage capital himself (Cottier, 2000). His monetary novelty, which today is more recognized as the definitive short/long impartialities model, was to try to decrease the danger in possessing long-standing stock places by having a short sell with the other stocks. In agreement with the long/short impartialities classical, Jones was therefore able to limit the jeopardy of the marketplace, which was current in the portfolio. Additional Jones achieved in attaining optimistic return from both when the market had gone up and down because of differences that are in the arrangement of long and short locations. The objective of hedge funds nowadays is still to make total returns in the similar way (Cottier, 2000). Jones also desired to develop the returns and tried to do so by expending influence (McWhinney, 2010). Then during the year of 1949 Jones had hurled the world’s first hedge fund.

Figure 2: Hedge Funds that are under performed.

During the next couple of years Jones would alter the construction of the hedge fund, changing it from a general to an incomplete company. He then added an inducement fee to recompense the partner who was handling the fund (McWhinney, 2010). Another main variance from the mutual funds is that a lot of the hedge fund administrators, to display that they believe in their decisions to try and reach the absolute returns, capitalize in private capital in to the account (Ineichen, 2003). To become shrewd to reach total reappearance of the location instructions of hedge funds which are less controlled than those of mutual funds. Ever since hedge funds are less controlled likened to mutual funds, this stresses that the hedge fund directors own superior info that about the marketplace and the obtainable advantage lessons than the even fund directors (Cottier, 2000). Because of the assignments instructions being freer, the hedge funds will be more reliant on a liquid market, where both buyers and sellars that are ready to purchase and sell at fair market value (Ineichen,2003).

Figure 2: Kinds of investment vehicles are investors looking at.

The hedge fund business began to rise in sometime around the mid-sixties when Fortune magazine tinted this new financial vehicle which outdid every current mutual fund on the market, occasionally by as much as 90% that took place in the last decade. Therefore the hedge fund manufacturing was here to stay (Ineichen, 2003). After the article started to became recognized a lot of persons that around the world had been trying to copy what Jones had been doing and in the end of the seventies there were over 150 hedge funds that were functioning in the marketplace (Cottier, 2000). On the other hand, the new hedge fund executives were very untested, and therefore the prosperous of hedge funds had followed in huge mortalities and many insolvencies because of poor management, which made the market silent for an amount of years.

With an article in the Institutional Investor magazine concerning the unresolved presentation of Julian Robertson’s Tiger fund, the populace’s consideration was yet again seized and numerous stockholders that were rushing into the business again which now obtainable thousands of choices to capitalize your capital in (Cottier, 2000). In the previous 1990s numerous well-known money managers unrestrained the traditional reserves to be capable to try their probabilities as hedge fund managers. Unhappily, likewise to what had taken place in the sixties, the market was unsuccessful again in the late 1990s sending off a lot of people to become bankrupt.

Figure 3: Hedge Fund Net Buys

On account of the attention in media concerning the failures of some of the hedge reserves in the last decade, a shift in the direction of more rule concerning the hedge fund business has occurred (McWhinney, 2010). In America, President Obama contracted the Private Fund Investment Adviser Act of 2010 in July 2010, therefore importantly altering the guidelines regarding the recording necessities for fund managers. The result of this act is that it has become a whole lot harder than ever to evade registering with the SEC which was meaningfully calmer before (Hedgecock & Loving, 2011).

These days, the common type of hedge funds is a restricted partnership or a partial obligation business, which can issue safeties in “private offerings.” Unlike mutual funds, hedge funds are exempted from the Investment Company Act of 1940, which regulates the structure and operation of mutual funds and requires funds to safeguard their portfolio securities, forward price their securities, and keep detailed books and records. This exemption provides hedge funds a great flexibility to select investment options. They can use short selling, leverage, derivatives, and highly concentrated investment positions to enhance their risk/returns. Hedge funds are also exempted from Securities Exchange Act of 1934; therefore they are not required to make periodic reports to SEC. The flexibility also has its own cost. Hedge funds have to limit the number of investors to 500 to qualify for exclusion from the regulations governing public issuance of securities. In addition, hedge fund investors must meet certain requirements. For instance, a qualified investor must have a minimum net worth of U.S.$1,000,000 or, alternatively, a minimum income of U.S.$200,000 in each of the last two years and a reasonable expectation of reaching the same income level in the current year. Hedge funds are not allowed to advertise in public. Due to this restriction, hedge funds report voluntarily to database vendors so that they can distribute the information and attract investors’ dollars. However, they may stop reporting if they perform poorly. Alternatively, they may also? stop reporting if they perform remarkably well and thus are closed to new investors. This typically creates a survivorship bias in measuring fund performance.

Figure 4: The Return Performance

Since hedge funds usually report their returns on a voluntary basis, it is not possible to accurately estimate the size of the hedge fund universe as well as to verify hedge funds’ returns. Collecting reliable information on hedge funds is a challenge, but according to an estimation of Van Hedge Fund Advisors, the hedge fund industry has been growing at an average rate of over 17% per annum over the last decade and is expected to continue at this significant rate. There were about 9,000 hedge funds operating in 2006 with a total assets value of USD 1.3 trillion.

1.2 Problem discussion

Risk management has always been a topic that has been complex, particularly when it comes down to the hedge fund manufacturing. Since hedge funds are able to apply many diverse forms of financial devices, it is very hard to discover a sole risk management approach that goes healthy with hedge funds. Although the industry has ben certainly growing fast over the last several years, there has not been much focus that has been put on how risk management should be done. The hedge fund manufacturing is a moderately new topic in Britain, where the first hedge fund was founded not more than 15 years ago. Because of this, not much investigation regarding the British hedge fund business and its risk management strategies has been actually been executed. Therefore, we discover it a stimulating theme to focus this thesis on.

Figure 5: Analysis of Hedge funds

From the time when hedge fund portfolios are built in a similar method as mutual funds, the risk management that is being implemented would need to be specifically important during this procedure when it comes to hedge funds. Therefore, we wish to find out if the fund managers are taking this into consideration when putting together their hedge funds. Another stimulating topic is to explore which one of the risk variables the fund managers’ are utilizing, because a lot of researchers query their strength.

We desire to study what position risk management at the moment have in the Swedish hedge fund business from a fund manager point-of-view, as well as if these views differ in view of the size of the hedge fund.

1.3 Purpose

The purpose of this dissertation is to be able increase the information of how Englis hedge fund managers are observing and managing various forms of risk and how they construct their portfolios with respects to risk management. This study also sets out to investigate how the risk sizes are utilized when it comes to risk management and how legal they are when directed to hedge funds.

1.3.1 Problem definition

This dissertation purposes to increase the awareness regarding how risk management is performed in hedge funds. From the above issue discussion the research questions can be expressed as:

How do British hedge fund managers observe risk in their portfolios and how are they able to manage it? How do fund managers put together their portfolios with respects to risk management?

How is risk measurement utilized when it comes to risk management and how practical are they when they are being applied to hedge funds?

1.4 Limitations

To thin out the field of study the study will put a focus on hedge funds that are being operated from Britain but who are not restricted to trade in properties and merchandises traded completely on the market. This is done in order to capture the views and mindsets on risk and plan of contributors in the market deprived of discounting global risks for instance those born from money trading and macro cost-effective changes. This will also grow the hedge fund manager’s aptitude to expand the portfolio, which should be an significant factor in the policy of the portfolio.

1.5 Perspective

This dissertation is written from a perspective of a fund manager, managers being persons who accomplish the different hedge funds. This dissertation will be interesting for those that are funding managers who request to upturn their knowledge regarding risk management and how precise the diverse risk quantities seize the risk when it comes down to hedge funds. It will also give an escalation in the information for individuals who request to capitalize or is presently capitalizing in hedge funds, as it will make them much more conscious of the complication of the hedge fund manufacturing. Therefore the rank for hedge fund directors to pay a well-reputable risk management strategy will be examined.

Introduction Chapter One

1

CHAPTER TWO: LITERATURE REVIEW

Even though the media and so many other investors have been perceiving hedge funds to be consistently risky, the evidences are that little about the hedge fund universe is the same. Some hedge funds hedge, while others take maneuvering marketplace risks. As a an outcome of the private and impervious nature of hedge fund capitalizing, a gathering of data tests exist for the reason that hedge funds are not requisite to report their revenues to controllers or any single folder. Much of the literature makes a description of certain adjustments being made and also the caveats to working with as-reported hedge fund revenues and risk statistics.

“Hedge fund” is a word used to label a wide variety of asset strategies. As a general rule, these strategies are less controlled and more impervious than long-only funds which are offered by old-style investment managers. Rather than taking a long-only contact to a single asset class, a lot of hedge fund strategies are involving the utilization of leverage, imitative products, multiple advantage classes, and selling that is short. The net market introduction of hedge funds can differ over time, which makes it more problematic to investigate presentation, manage risk, and choose on the appropriate distribution of hedge funds in investor portfolios.

Stulz (2007) lures several differences among mutual funds and hedge funds. Hedge fund possessions have developed explosively to over $1 trillion, that is at the present more than 10% of the scope of the mutual fund business.

Figure 6: Analysis of Challenges

In places like the United States, moats of the mutual funds are certainly a requisite to account to the U.S. Exchange and then the Securities Commission (SEC). This duty includes filing a brochure, full exposure of portfolio possessions on a semiannual basis, and the everyday delivery of a net benefit worth (NAV). Mutual funds are also subject to the restrictions that are on leverage. In the interchange for this instruction, mutual fund employees are allowed to market their produces to an widespread inconsistency of investors, ask for low smallest assets, and bid universal availability to investors.

Hedge funds can also earn some exemptions that are from a lot of these monitoring necessities. By making a choice not to market their assets to the society and regulating fund investments to self-assured procedures of high-net-worth investors, hedge funds are exempted from admittance requests. The free nature that regards the hedge funds, previously, just indications to the capability to deliver less release to investors and miniature or no disclosure to non-depositors. The compressed nature of hedge funds makes it difficult to compute figures that are exact on the size and the proportion as hedge funds for the aim that even their being may not be revealed.

Despite the fact that they are not a part of the disclosure requirements, hedge funds are not all the way unfettered. Hedge fund managers are obligated to still go along with their laws which are resolute by safeties regulators. Hedge funds may not distort performance, bargain client funds, or engross in insider interchange, calculating exchange, or front running.

Figure 7: The factors of considering Hedge Funds

In contrast to the low minimum asset and daily fluidity of mutual fund portions, investments in hedge funds require a little less liquid. A lot of hedge funds document a NAV towards the conclusion of each month or calendar sector. Numerous hedge funds also have lockup eras that limit removals from the hedge fund for some era of time. General lockups at hedge funds are normally one and two years, and those that are three-year lockups are turning out to be more common. A “hard lockup” makes the point of stating that that no necessities that are existing for the development of hedge fund assets for the specified era of time. A “soft lockup” age proposes a least investment age, but savers have the aptitude to sell their stocks before the expiration of the lockup era by disbursing a recovery fee, which is frequently in the assortment of 1-3%. Consequently of supervisory requirements that limit the amount of depositors in each fund, hedge funds characteristically have high minimum investment supplies, usually reaching from $600,000 to $12 million per investor.

2.1 Fee Structures

A lot of information has been documented with concerns about the hedge fund fee constructions. Hedge fund demonstration is typically documented net regarding ever fee. Stulz (2007) makes the clarification that hedge funds can make both management charges and incentive payments. A classic management fee is 1-2% every year that is originated on the properties under management. Incentive fees are also documented as presentation fees, are calculated as a set amount of the incomes on the fundamental pond of possessions. A hedge fund manager could basically get around 12-25% of proceeds which are furthermore to the management cost. Not a lot of mutual funds are accusing performance dues since U.S. rules need the dues to be symmetrical, which means that the investment manager has to be able to share likewise in both gains and losses.

Hedge fund incentive dues are generally paid on a quarterly or annual basis and are regularly being subject to a high-water mark transport. These dues are really being earned by a manager soley among the time eras of positive asset performance. The high-water mark delivery makes the assurances that incentive fees are established only one time for an expected dollar of investment return. For instance, a hedge fund can get about a 10% fee, net of fees, in a calendar year for which inducement fees are salaried. If the fund begins to bring up a return of -7% the following year, there is not any incentive dues which are being paid becasue the presentation was not very good. In the next year, the hedge fund brings back 20% return. The incentive dues in that year are remunerated just for the increases in additional of the high-water spot, that is the 7% of advances in additional of the NAV of the account which occurs at the quality of the year. Anson (2001) has branded hedge fund incentive dues liberated selection on the motive that the manager is making high fees for bigger investment fees but does not share in any stockholder wounds. This nonappearance of partaking in compensations could bring an stimulus for the manager to take potentials that are larger than the shareholder would choice. An off setting issue to this irregular payment construction is when the asset boss has capitalized a substantial serving of her or his net worth in the fund, which would motive the manager and the investor to alongside experience trading harms.

Even though a big amount of hedge funds are known for using a high-water spot in their payment panels, a small minority also use what are named hurdle rates. Hedge funds with these type of hurdle rates do not make any incentive fee till a minimum return verge has been touched. Typical hurdle charges can be a specified temporary interest rate or a fixed yearly rate, for instance 7%.

Some stockholders have selected not to assign possessions to hedge funds for the reason that the scope of dues salaried to hedge fund managers. Asness (2006) proposes numerous alterations to hedge fund fee constructions. Higher hedge fund fees would need to be salaried to managers that have established skill by making alpha, which is a high return after regulating for all appropriate risks. Leveraged hedge funds can also defend higher fees for the reason that these strategies are earning a greater benefit from the manager’s understanding for each dollar of capitalized capital. Hedge fund savers are beginning to separate alpha from beta in their presentation control, guiding them to ask hedge funds to start charging much lower fees for beta introductions to old-style market factors. By substituting high beta hedge funds with hedge funds or index fund beta repetitions investors are able to substantially decrease the dues that they are paying. As the hedge fund business starts coming to depend on more on recognized investors, such as things like the pension plans, and less on high-net-worth characters, hedge fund charges for larger investments are probable to drop.

2.2 A Varied Variability of Hedge Fund Strategies

Black (2004) appears to be delivering an entire imprint of hedge fund approaches and follows the fund type organization of what is called the Credit Suisse/Tremont Hedge Fund Index (www.hedgeindex.com).

Arbitrage-based funds typically have a lower standard deviation of returns because they are the hedge funds that explicitly hedge. By design, the risk and size of the long positions are highly correlated with the risk and size of the short positions. In many cases, these funds have short volatility exposures that lead to gains in quiet markets and losses in turbulent markets. These strategies typically have annualized standard deviations of 5-7%, which result in the highest Sharpe ratios of all hedge fund strategies. Many of these strategies, however, make money slowly and misplace money rapidly, which can lead to the unattractive negative skewness and fat tail risk ( large extra kurtosis).

The Convertible bond arbitrage methods usually buy a portfolio of adaptable bonds and seize positions that are short in the connected equity safety. A convertible bond is characteristically a shared debt matter that comprises a call choice on the stock cost of the issuer. Investors are starting to accept a yield that is lower on convertible bonds that are compared with selection-free debt of the similar issuer since they are salaried for the lower revenue by means of the call option. For instance, a business that classically borrows at 8% in the bond marketplace could dispute an adaptable bond that has a yield that is around 4%, which certainly prices the call option at the present worth of the inevitable 3% interest. A convertible bond strategy is deemed to be market neutral when the price of the fund does not change with small changes in the underlying stock prices.

Market neutrality is achieved when the size of the short-stock position matches the long-delta position of the embedded call options. Convertible bond arbitrage performs well in times of declining credit spreads and high stock price volatility. In times of rising credit spreads, convertible bond arbitrage funds can suffer steep losses because bond prices are falling quickly and liquidity of convertible bonds declines rapidly in a flight to quality market.

Equity market neutral funds usually are the ones that are seeking to take, on average, a beta exposure that is zero to impartiality markets. A lot of these funds are know to purpose for a zero disclosure that is suppose to be on average but can take risks that are temporary of up to a beta of 0.20. Even though beta risks are reduced in this plan, fund managers may be taking risks that are substantial in other places of the fairness markets, like those of the market capitalization, worth development, or industry. To get top the beta neutrality, the beta and size of the long locations are carefully matched through the beta and the size of the short positions. Many of these market neutral funds are motivated by means of a quantitative procedure. Quantitative funds that are known to having longer holding periods (months) can be found on factor models with such subjects as value, growth, drive, and pays value. Quantitative funds with smaller holding eras (minutes and then to days) can be really named statistical arbitrage and are mostly founded on interchanging long-short pairs of stocks that have a high long-term association with different short-term stock actions.

Even the funds that are driven appear to be focused on a what is considered to be a single strategy, for instance distraught reserves or risk arbitrage. Multi-strategy applications of certain event driven investing can mix these two methods with others, for instance supplements, cross-possession, or even index reconstitution methods. Funds that are distressed usually are invested in debt safeties of issuers that are currently in default or that are eventually expected to go into a quick default soon. The funds that are distressed have, maybe, the most important wateriness jeopardy of any hedge fund strategy since a lot of the investors are not really willing or able to purchase the debt of firms that are at the moment in bankruptcy. Investors that are distressed can be inactive, just eager to earn the profit on the bonds they buy. Others, on the other hand, are very active shareholders who will become convoluted in the bankruptcy procedure. Capital construction arbitrage requests of distressed savings are comprising some spreads that are really among a lot of the sections of a given business’s capital construction, maybe by purchasing debt and being able to sell short the stock or trading credit default swaps that are against all the stock options.

Figure 8: Growth in Assets

The Risk arbitrage, or merger arbitrage, funds are seeking to start predicting the result of announced business merger transactions. The classic application is to buy the stock of the target business and sell short the stock of the acquiring corporation in the percentage of the stock swap business. This strategy is the description of occasion risk and that the risk was in the higher amount since these assets make money gradually and lose money rapidly. The target reoccurrence of a fruitful asset could be solitary 6-:12 percentage, which is then earned among the period of 7-20 months among the statement and consummation of the arrangement. Risk arbitrage funds at times do experience some form of substantial losses especially when there is a planned merger has been cancelled since the stock of the target organization can drop about 20% or more in one whole day. Risk arbitrage is thought to be a short instability strategy for the reason that the hedge fund has been selling insurance that went against a broken deal in deliberation of the predictable return of the finished deal.

Fixed-income arbitrage classically capitalizes with a positive income location that welfares among the era periods of decreasing credit spreads. Fixed-income arbitrage strategies are purchasing bigger yielding bonds, that are usually investment- or hypothetical-grade business bonds, mortgage-sponsored safeties, or debt that is issued by the emerging market governments. Higher excellence obligation is sold or power is learned at lower rates. The strategy typically makes an optimistic income since the bought bonds have a higher harvest than the higher value obligation or the price of the influence. This strategy welfares when credit spreads are steady or constriction and markets are relatively liquid. Fixed-income arbitrage funds can suffer catastrophic losses during flight to quality markets because credit spreads widen quickly, leverage becomes more expensive, and markets for lower quality debt become much less liquid.

The Medium volatility hedge fund strategies are going to take both long and short places, but these locations are not always intended as hedges. The short and long places can certainly have a difference that is dramatically in risk and size, often outcomes in a net long location in a fundamental stock, bond, product, or money marketplace. These plans have an average instability of 12-15% every year, which is to some extent less than the instability of the fundamental markets.

The Global macro funds are normally the main focus that are on the long and short reserves in comprehensive markets, such as neutrality directories, moneys, products, and interest rate marketplaces. Rather than picking particular safeties, macro funds that are focusing on the macroeconomic display, choosing ability lessons and nations that are going to benefit from the manager’s marketplace perception. In a lot of situations, these kind of views are normally driven by market modifications that are connected to governmental actions, for instance the change from fixed to fluctuating rate moneys.

THE INTERNATIONAL HEDGE FUND INDUSTRY

The trend that is going toward the rule of hedge funds is showing imminent. The American and European markets are presently experiencing regulation in the industry. The Asian markets are promoting a less regulated tactic in the hope that funds will be reserved from more regulated parts to more comfortable and stockholder friendly areas.

The Asian market marvel has been raising the question of whether regulation is going to be able to sustain an industry that is thriving or whether it will daunt stockholders and advantage managers from the augmented red tape. In the places like Great Britain, regulations would have brought administrators beyond $27 million under management or over 20 investors under severer management by the SEC. The manufacturing confronted the instruction and is at present still debating proceeding what extent to control the business.

There is a move gearing toward the self- regulation in the U.S. where prominent statistics in the SEC are expresseing support for a self-regulatory scheme. If the hedge fund business is able to understand that the welfares of self-regulation overshadow their prices, for a few dollars more the business can defend itself from unwanted government interference. Harvey Pitt, who controlled the SEC during the years of 2001 and 2003, observed on hedge funds, mentioning “absent any real proposals from hedge funds, legislators and controllers will be happy to suggest their own answers, no matter how unreasonable” (Chasan, 2007).

In England, the main regulatory association is the Financial Services Authority (FSA). This body emphases on managing the marketing of hedge fund produces and then controls hedge fund managers themselves. Furthermore, the FSA is fretful with the assessment by hedge fund managers of their own tools, chiefly when they are highly compound.

In reply to regulatory subjects, the Hedge Fund Working Group (HFWG) had been recognized by an ad hoc group of 15 hedge funds to grow a set of best exercise values for the business. A group of standards that are certainly focusing on the investor defense, complete risk and business supremacy was printed on January 22, 2008 (Horsfield-Bradbury, 2008).

The governance morals safeguard that estimate preparations are in place so that conflicts of awareness are condensed and that hard to worth properties are justly and reliably valued.

The values also speak to the concerns that are arising from the knock-off effects that are of the systemic risk. Systemic risk stalks from difficulties of estimate and risk valuation and discovery. If LTCM had sufficiently appreciated the danger of the Russian deflation, or revealed its high influence, it is likely that their counterparties would have understood the risk of their savings (Horsfield-Bradbury, 2008). Self- regulation could have banned the failure of this big hedge fund. In the Asian markets, specifically Hong Kong, hedge funds are indulged to record with the Securities and Future Commission (SFC).

These fund managers are obligated to defer to proof of knowledge and operation guides and are exposed to unsystematic audits. In Japan, all individuals that are giving investment guidance are requisite by the Investment Advice-giving Business Law to list with The Financial Services Agency, which is the supervisory body.

Reason why Hedge Funds Fail

Even though there are some hedge funds that are employing some very conservative investment methods, they can normally be considered as high-risk, high-return procedures. They necessitate trading actions that are thought to be less conventional than the “long only” world of mutual funds. Instances of these types of activities are investments in multifaceted and illiquid safeties for instance derivatives and over-the-counter (OTC) agreements.

Figure 9: Investing and Failure

With the growth of an augmented institutional investment base, for instance pension funds, a lot of the money that derives from the retirees and others will be unsuspectingly exposed to the losses of hedge funds. Giraud (2005) refers to about 400 hedge fund ends that occur per year. This emphasizes the position of categorizing the particulars why such funds are not working.

According to a report that was published in a document for Congress, Jickling and Raab (2006) cite three reasons for hedge fund failures all over the world:

Financial concerns, or losses curtailing from disapproving market moves;

Operational questions, for instance errors in trade dispensation or mispricing multifaceted, opaque economic tools; and Scamming or misbehavior by the fund management.

Another study was done by Kundro and Feffer (2002:42) examined the disappointments of hedge funds that are have been discovered and found that roughly 58% of the failures (i.e. funds that have stopped procedures with or without recurring the capital to their stockholders) are openly connected to a failure that involves a lot of different operations in the processes. The operational risk consequently importantly does exceed the risk that are all being related to the investment plan. Figure 2.7 illustrates the analysis.

Figure 10: Performance attribution

Even though there are some concerns of a hedge fund manager and investor, there is usually some economic risk, risks associated with operative faintness which are developing with a lot of importance. When operational concerns are the root reason of so much failure, it is connected with stopping a fund from handling a crisis condition that is suitably in an unforeseen monetary context (Giraud, 2005).

Kundro and Feffer (2002:42) each had made and identification to a number of operational risk issues that all together appear to account for about half of all hedge fund that have failed. These factors encompassed embezzlement of funds and fraud, distortion, unauthorized trading that is unauthorized or trading that is done outside of guidelines, and resource/infrastructure inadequacies.

The matters that motivate the operational risk factors that were talked about above are linked to the estimate of the fund’s properties. Valuation is a procedure of defining the fair- market-worth that’s is for all the locations that establish the fund. With the circumstance of deception and parody, failure creates from dishonesty regarding the worth of the assets detained. Furthermore, the reserve/infrastructure subjects are resulting from the incapability to precisely worth or risk the funds book.

Since the estimates play a vital character in operational risk management, the matter has become actual interesting in hedge funds. Issues that are linked to assessment of portfolios will be probable in becoming the next vital “black eye” for the hedge fund corporation. Except convinced practices start becoming much more widespread, hedge funds will always be facing a possible disaster of confidence with official and high net worth stockholders (Kundro and Feffer, 2002:42).

2.2.7 THE VALUATION ISSUE

Both regulators and investors are worried when it comes down to the valuation of the fund’s possessions. The distress is resulted from the trouble of appreciating multifaceted or illiquid possessions, and from the potential chaos of interest that is among the manager and investors in the fund. When these are consistent, for instance when the hedge fund manager has input into the valuing of the hard to value assets, the concerns are amplified.

Figure 11: Failure of Hedge Funds

Because hedge are funds that are being invested in the securities that trade uncommonly, where transaction cost is not willingly available on vital wires and feeds for instance Bloomberg, bids and propositions are not that informal to come by. The quotes from Broker have to be required in order to start getting get a sense for what the place is actually worth. Some of these quotes of mortgage sponsored securities, for instance, can effortlessly differ by 30-40%. Such securities are extremely complex and may be problematic to value deprived of the utilization of a mathematical model. The models are able to make use of expectations and predictions that are personal and open to some questions (Kundro and Feffer, 2002:42).

Figure 12: Alternative Investment survey

Because hedge fund managers sometimes do invest their own money in the funds, they have a an incentive that is powerful to show robust (or hide weak) presentation. The characteristic trouble to price compound or illiquid savings worsens the subject. All these issues happen in an environmental setting with slight regulatory supervision and interior controls.

Chapter Two Literature Review

CHAPTER THREE: METHODOLOGY

3.1 Research philosophy

When it comes down to research philosophies, there are normally three viewpoints that are leading the literature; interpretavism, realism and positivism,. (Lewis, Saunders & Thornhill, 2003).

Positivism takes the goal at a scientific method to research, which does seem seek to work with a social noticeable realism that is from where one can attract general assumptions. The researcher can consequently take an impartial part where he can make simplifications, free from values. The focus does lie upon calculable observations that derive from which one can analyze and review the studied purpose. Interpretavism, instead, purposes to study the philosophy, which speaks that the commercial world is too compound to be widespread and examined statically. Nearly every commercial event is exclusive and difficult and purposes of social interactions between persons. Therefore, researchers are trying to get an understanding of the complexity and the dynamic commercial world to be able to investigate, inspect and draw conclusions regarding it. (Lewis et al., 2003)

Further, realism is founded on the indication that there is a reality, which is independent of human values and the way people think. However, there are strong social influences t that affect the human behavior, even though most are not really aware of it. Hence, individuals are certainly being influenced by social marvels’ and academics need to seek in getting the knowledge of the humans’ socially assembled world and personal evaluations. (Lewis et al., 2003) Numerous research philosophies are suitable contingent on the type of study one decides that they wanted to conduct. On the other hand, most of the business connected studies that are being performed falls anywhere under positivism, interpretavism or someplace in between. (Lewis et al., 2003)

Our study shadows mostly the interpretivistic attitude since we trust that the commerce world is highly intricate and a purpose of social connections amid sure individuals and conditions. Also, we have the belief that this study’s focus, risk management in Britsih hedge funds, is dependant upon issues exclusive to each business for instance the fund managers’ own knowledge, amount of capital that was invested in the fund, business culture, etc.

2.1.1 Research strategies

There are so many different research techniques that are really within business studies. Nevertheless, exploratory explanatory and descriptive studies are the most typical. If a study has numerous determinations, it can also make usage of numerous research approaches (Lewis et al., 2003).

The exploratory approach goes after the increase of the knowledge of what is presently occurring, discovering new understandings and exploring positive phenomena’s in a new way. It is also very helpful when a person desires to explain the understanding of a certain issue. Therefore, it is a supple and adaptive method. Alternatively, a descriptive approach really does aim at describing and explaining why certain phenomenons are happening. Descriptive strategy has a focus on demonstrating and giving a proper illustration of events, people, circumstances or conditions and is suitable for studies of an overall nature. Lastly, there is the descriptive approach, which purposes to start unplanned associations among variables by studying exact circumstances. An example is when quantitative data and statistical examinations on a firm’s flawy produces start following after the explanatory approach. (Lewis et al., 2003).

In this dissertation, mostly exploratory and descriptive research policies will be smeared. Ever since our aim is to appreciate how British hedge fund managers are perceiving and managing risk in their funds, how they are putting togther their portfolios and how precise definite risk depths are to seize the risk in hedge funds, we believe that these research plans are ideal.

2.2 Research method

The selection of research method needs to be determined by the determination of the investigation and the dilemma definitions. Within research methods there are mainly two discussed, the inductive research method and the deductive research method. The aim of both of these methods are no different, in order to increase the knowledge of the research questions. Nevertheless, they are dissimilar in how they grasp that goal. (Andersen, 1998)

With a deductive research method, a person tries to analyze the research that does exist, familiarize and provide meaning to the qualitative data (Andersen, 1998). A deductive method is considered by a small degree of interpretation and a comparatively organized method. The deductive approach creates use of statistical examinations to be capable to settle positive hypothesis and then attempts to make simpler the world that is seen through them. Therefore, this tactic does not reflect certain events and with replying to them by means of interviews, in its place it tries to apply already established principles that are established and then test a positive hypothesis (Holme & Solvang, 1991). According to Carlsson (1991), this method is typically used when working with quantitative data, and for the reason that we will work with qualitative data in our thesis this technique will not be exploited.

The inductive research method purposes to comprehend the world today by means of empirical studies that are already recognized, which rings things to new interpretations and in conclusion to fresh theories. Testing hypothesizes via statistics is not always utilized; instead the method is usually done through interviews (Carlsson, 1991). With an inductive technique one struggles to gather qualitative statistics to later realize what questions need to be investigated further. Additional, one attempts to discover conclusions that are coming from experiences and events that are real, but also construct a theory that is well originated in the qualitative data one have composed (Lewis et al.,2003). An inductive method can be categorized with a high gradation of clarification and a relative formless method. When selecting an inductive research method, it is valuable to try to partner and narrate one’s studies to the current literature and theories in the arena of investigation.

The research technique we will utilize is the inductive technique. This selection was made because there already exists a vital quantity of studies that have been done on this issue. There is therefore no sense in trying to test a hypothesis by means of statistics, which does makes the inductive research manner suitable. This method is most frequently utilized when it comes down to qualitative facts rendering to Carlsson (1991), and frequently done through interviews. Additional reason for selecting the inductive method is that Lewis et al. (2003) makes the argument that when the sample size is comparatively small, the inductive research approach is more suitable to use.

2.3 Method of data collection

In this section of the methodology chapter, a plan of the chosen technique and how this selection was made will be given. We go on to further clarify how the data, essential to be able to reply to our research questions, was collected.

2.3.1 Primary and secondary data

One essential portion of the methodology when writing a thesis is to select among primary or secondary documents. Primary data basically means that the researchers’ desire to find information that is new, therefore this technique is more involved and near to the topic of research. When creating utilization of the secondary data method, researchers’ desire to investigate the subject of investigation more accurately and endeavors to look for the information that is required in previously obtainable data. (Lewis et al., 2003)

Primary and secondary data have a close correlation to quantitative and qualitative methods. Lewis et al. (2003) argues that when using a qualitative approach, primary data is frequently a part of the research. One of the reasons to make use of primary data is that the researchers’ are able to modify the data based on certain research questions, hence be able to collect the information that is needed specifically for their particular study (Lewis et al., 2003). Lewis et al. (2003) argues further that primary data is often collected through interviews.

Secondary data is a little more connected to the quantitative process. The data and information have been composed beforehand, formerly for other determinations. These facts are utilized due to the increased speed in which you can collect data, costs that are lower are related with gathering data and for convinced research questions, it might be precisely what is desirable (Lewis et al., 2003).

The empirical section of this thesis comes from both the data that is primary and secondary. Because it was problematic to find important facts and data concerning risk management in hedge funds, gathering primary data from the British hedge fund managers was vital. Some data that was secondary information has been collected through dissimilar databanks, for instance Google Scholar.

2.3.2 Qualitative and quantitative method

Inside the research are there are two chief methods utilized, the qualitative and the quantitative. They each have in common that their determination is to make a better accepting of the culture, that we are living in, and how persons, groups and organizations influence each other through actions. Apart from the exact purpose, the two approaches are quite dissimilar. (Holme & Solvang, 1997)

The qualitative methodology, according to Holme and Solvang (1997), is concentrating at emerging an understanding of the topic of research, in place of detecting a particular event. Lewis et al. (2003) contends that the qualitative method is more suitable to be capable to reply to questions and also clarify how and why they occurred and to provide the reader a profounder accepting of the specific subject. The qualitative method approach pursues to clarify a specific event or experience and define how different factors are interrelated. When the process is at focus and one is aiming to understand what really occurs, it appears natural to discover sure specialists, share their involvements and attempt to comprehend how they understand events. Therefore, one has to discover a smaller but more exact quantity of statistics that provides a stronger and more exact focus. (Bell & Bryman, 2005)

The study in this dissertation pursues the answers to research questions regarding how risk management is perceived and managed in British hedge funds and how the hedge fund managers’ use and value risk measurements while dealing with risk management. The risk management in Swedish hedge funds will vary depending on several factors such as size and age of the fund and its managers, but mostly because that risk management in every hedge fund is individually developed. Hence risk management will look very different from firm to firm. Thus, we have chosen the qualitative research methodology that have a more exploring approach and is suitable to answer the questions that this thesis study concerns.

The quantitative methodology’s focus lies in giving explanations (Holme & Solvang, 2007). The quantitative data takes the form of numbers and can be produced by different research methods where the most common one consists of surveys (Denscombe, 2009). This particular methodology’s purpose is to collect a larger amount of data and then be able to analyze and interpret it with assistance from statistical techniques. Hence, the quantitative method is used to clarify the relationship between different variables and determine how much different factors come into play (Holme & Solvang, 2007).

We believe that the understanding of risk management in Swedish hedge funds is not primarily a question of numbers; instead there are more unique aspects to it that differentiates the funds from each other that can only be derived from interviews. The problem, the solutions and the underlying factors in this thesis problem discussion and purpose are not easily quantified. Hence, the qualitative methodologies are more suitable for this thesis.

2.4 Interview

The method of using the interviews started off by collecting the primary data where each has its own advantages and disadvantages. One of the chief advantage is that a personal interview can be adaptable and flexible. In an interview an individual has the possibility to be able to follow up with some ideas that happen to come up during the interview and to construe answers provided during the interviews in a different way contingent on tone, pauses and body languages. This is not possible in a reply that is written on a questionnaire that is sent out. If one afterward needs extra material or explanation of the primary data calm this method is supple enough so that one could just advocate the interviewees again if needed (Holme & Solvang, 1997).

The interviews have a disadvantage as well. This con is that they are time-consuming as they typically need one to three hours to achieve. Also it is also takes up a lot of time just to analyze and classify the data composed during the interviews (Holme & Solvang, 1997).

As specified in the purpose, the goal of this thesis is to deliver a better accepting of the topic; as a result the questions will be ready previous to the interviews. This all together including the discussions that are throughout the interviews should provide important results. As a researcher, I believe that this will give the thesis some valid empirical data that will be associated to just working with a questionnaire. The issue with a questionnaire is that it is not likely to respond to unanticipated views and answers that are from the persons interviewed, which might be very important for the thesis. Therefore, the researcher has chosen to use the interviews and further qualitative methods can be divided into three groups, which are obvious contingent on how severe the interview is lead. The three groups are the following; semi- structured interviews and unstructured interviews,. (Darmer & Freytag, 1995)

In the interviews done to gather the primary statistics for this thesis the researcher sought to ask the similar kind of questions in all interviews but to likewise have the option to ask suitable questions in reply to individual manager’s responses. Therefore, the semi-structured method is the most fitting interview practice for the thesis. According to Darmer and Freytag (1995) the semi-structured interview routine is a combination of the unstructured and the structured practices. This is for the reason that the technique makes use of continuation questions that permits admission to more complexity in the subject and also the option to reflect unforeseen data resulting from the subject. The structure can consequently be seen as a flexible way and the order in which the questions are being asked is not an important problem. As an interviewer, the ready questions will be utilzed throughout interviews to make sure that all research queries of the thesis are enclosed (Darmer & Freytag, 1995).

There are an insufficient explanations as to why the unstructured and structured methods of interviews are not being used. The matter with the unstructured system is that when the examiner has nothing to follow, the applicant inclines to take over and the questioner becomes a lazy listener. The problem with the pure structured technique is that the interviewer tends to follow the prepared questionnaire too strictly and there is usually a lack of follow- up questions and interactions between the participants (Darmer & Freytag, 1995). Thus, neither of these two techniques is appropriate for this thesis and therefore have we chosen a mixture of these two techniques, the semi-structured technique.

2.4.1 Interviewee selection

It is imperative to reflect the determination of the thesis when choosing the examinee sample. According to Lewis et al. (2003), there are about two chief methods that are being utilized for things like probability or non-probability and sampling,. The selection that is among them comes from the drive of thethesis. Probability sample is connected to statistics; it is utilized when one wants to be sure that the example picked is as unbiased as possible. The likelihood sampling is typically done in quantitative studies where there is a big quantity of statistics that is to be scrutinized (Lewis et al., 2003). The researcher’s thesis is a qualitative study which puts the emphasis on how risk management is observed and accomplished in hedge funds, where the hedge fund managers are questioned and probed in complexity. Therefore, the non-probability system is utilized in this thesis.

To be able to select the applicants there were some prerequisites. The applicants are fund managers or similar in the British hedge fund industry and they have a profound familiarity of how the risk management is implemented in their hedge funds. From these features the researcher picks roughly 10 hedge funds, 5 superior that achieves about 1 billion SEK and 5 lesser ones that are dealing with fewer than 1 billion SEK. As of these 10, six respondents initially acknowledged to contribute to be a part of the interview. From these six, four final interviewees were then picked, two from firms that are much bigger and that are managing more than 1 billion SEK and about two that would come from firms that will be much smaller and that are managing less than 1 billion SEK. Before everything took place, the interviews were showed we emailed the interview requests to the applicants, which was selected for the thesis (Appendix 1). The purpose is that those being interviewed could get a better insight to what type of information the researcher was looking for and therefore they can arrange themselves for the interview in a way they originate suitable. Alongside these four interviews we also have taken interaction with the controlling body in England that supervises the hedge fund industry, Toscafund. The researcher chose to contact Toscafund to get their view on how risk management is being perceived and how it is managed in British hedge funds also as how usable they discover the diverse risk capacities to be when it comes to capturing the risk in hedge funds. Because the researcher’s focus in this thesis is risk management within British hedge funds from a managers’ perspective he saw that the contact with Toscafund could be a valuable praise to obtain a better accepting of the subject. Toscafund decided to reply to a written questionnaire that had been emailed to them (Appendix 2). These four dialogues and the written reply from Toscafund will be the researcher’s primary data, which will provide us awareness in to how risk management is observed and managed in hedge funds.

Since a lot of these hedge fund managers in Britain are situated in London the researcher made the decision to conduct the interviews there. The researcher lead four interviews over two days, early April 2012. The researcher received the reply to the questionnaire from Toscafund in the middle of April 2012.

The example assortment of four fund managers and the regulatory body of Britain will not be capable of giving a whole picture of how risk management is being perceived and then managed in British hedge funds but will give a bigger accepting of the managers’ interpretation on risk management. On account of that the non-probability sampling technique was selected, the researcher was not able to make any deductions founded on data (Lewis et al., 2003).

2.4.2 The questionnaire

Ever since the researcher picked a semi-structured interview, as clarified earlier, he had previous to the interviews fashioned suitable questions and follow-up queries that could be utilized during the interviews. These discussions had occurred in the flesh since it, according to Lewis et al. (2003), licenses us to increase trust and also an one on one contact with the applicant that is tremendously important to obtain dependable replies to the questions. As can be understood in Appendix 1 and 2, the questionnaire is constructed on open questions, which documents the interviewee to contribute his replies in a way which might provide more important statistics to us than if the queries were intended in a more closed fashion. Lewis el al (2003) additionally makes the arguement that an individual interview allows him to also adapt some questions and even discover new ones in reply to the responses that are established. We are too able to clarify the questions in case the interviewees do not comprehend it totally.

Previous to the interviews, the researcher shaped our questions in a method so that they would be able to answer the research questions. Therefore, we would in the future be able to utilize this facts to reach at a valued conclusion to the aim of the thesis. Underneath the researcher will present his research questions and sub-groups that are connected to all research question. From the questionnaire (Appendix 1) that the researcher utilized during the interviews and questionnaire (Appendix 2) done with Toscafund, in the end there were nine sub- categories. An account will be done of these sub-categories to make it understandable why we discovered them chiefly stimulating for the consequence of this thesis. These sub-categories will likewise be utilized when giving our main statistics and examination in chapter four of this dissertation, Empirical findings & Analysis. The researcher discovered it more effective to write the thesis in this manner and then believe that the reader will discover it calmer to follow when some of the questions and responses are put together for a more whole opinion of the composed primary data.

The first research question “How do British hedge fund managers observe risk in their portfolios and how do they cope with it?” can be separated into the next sub-categories:

The meaning and description of risk — It is significant to differentiate among every manager’s descriptions of risk as this will help as our foundation for understanding how he or she perceives the idea of risk. The meaning of the nature of risk will promote influence of the manager’s outlook on the controllability and features of risk.

The explanation of risk management — This is dynamic with regard to understanding how every one of the manager’s view the practicality of risk management will touch the risk management procedures applied in the portfolios.

The exploited risk management approaches — This will display how all the manager efficiently manages risk; it will additionally label the approach of the portfolio by asserting characteristics for instance geographical importance, divergence and hedging strategies.

The dissimilarity among the measurement and the administration of risk — This subject will be pertinent as investigation in the field frequently references the unclear differences among the two. The managers’ assessment of the alterations may demonstrate to be significant for our examination about the subject.

The researcher second research question “How do British hedge fund managers build their portfolios with respects to risk management?” has the resulting sub-categories:

The management of risk in the manufacturing course — This will give a synopsis as to how risk management is applied in the portfolio and if any restrictions, limits or other issues that disturbs the accessible approaches for the managers exist.

The features of the portfolio — This query will deliver understanding in to how well-informed hedge fund managers are regarding how their portfolios perform in dissimilar market circumstances and in reply to definite events. The researcher will additionally decide how, and if, managers apply situation examination and/or stress test their portfolios.

The sub-categories to the researcher’s concluding inquiry question “How is risk measurement utilized when it comes down to risk management and how binding are they when functional to British hedge funds?” are:

The risk variables being utilized — This query will aid as the basis for the researcher’s research concerning risk dimension by observing what risk variables the managers’ really apply in their portfolios.

The rationality of the variables — A dialogue about the legitimacy and correctness of risk variables will examine how hedge fund managers are perceiving the different risk measurements that are being utilized and how precisely they believe the variables seize the true risk.

The consequent use of the variables — This question will additionally grow the difference among risk management and measurement by observing how managers utilize the intended risk variables and how they use them for increasing a well-operative risk management organization.

2.5 Primary data analysis

According to Kvale and Brinkmann (2009) there are three dissimilar periods to how empirical substantial must to be handled. The first period is the structured phase where the data that is empirical is moved from an audio file to a printed paper. When the dialogs were lead, the researcher made sure that he transferred all of the recordings made during the time of interviews and then wrote the replies from every question that was on the paper.

The second stage, which is known as the demonstrative stage, brings an emphasis on the important information among the data that is being gained from the interviews and leaving out the information that has no contribution to the thesis. Energetic during the course of this stage is to put importance on the determination, therefore the important facts will be much easier to distinguish (Brinkmann & Kvale, 2009). When the answers to those who took part in the interview was written down the researcher made a more complete analysis and all that was unconnected to our resolution was detached. Because that we put the questions from the interviews into nine sub-categories the responses from the applicants were also accessible in the same way in section 4.2 of this study. This way of presnting the applicants made it less complex to make the contrast from one fund manager to another and likewise in contradiction of usable theories. The researcher trusted that the reader will also find it much easier to comprehend the interviewees’ insight of risk management in British hedge funds and the changes among them.

The third and concluding period is the distinct period of making a whole examination of the interviewees’ replies and viewpoints regarding risk management. This is equipped to be able to clarify the replies and consequently understand if the replies brings new statistics and angles to the thesis (Brinkmann & Kvale, 2009). The empirical results will be clarified in the nine sub- categories and combined with the theoretical outline the reader will find a more whole examination.

In the event that the researcher had a hard time accepting any of the replies or getting to some replies that could turn out to be not satisfactory, the interviewees had made the promise to answer the researcher over e-mail or even by telephone. This is because of the personal association recognized when the interviews had been conducted. The examination of this thesis is discovered together with the empirical answers in chapter four of this thesis.

2.6 The credibility of the study

In this unit the researcher will further label the working approach that he had have used in this thesis in addition to discussing the reliability and validity of the study.

2.6.1 Working approach

When leading a qualitative research there is always a certain risk that researcher’s bias could possibly arise from the fact that people are involved through out the collection and with dispensation of the data of the research. Rendering to Andersen (1998) it is for that reason vital that the writer is self critical in his approach to working and is not creating any patterns, which does not obviously exist in the data that was collected.

The researcher have chosen to divide some sections of the thesis. Once one of those parts has been written it has been analytically studied to remove any risk of researcher prejudice. Throughout the course of the 3 writing of the dissertation have we debated numerous philosophies about what material to be comprised in every paragraph and section. This is done to include us both through the dissertation in the same manner as if the study that is broken up.

2.6.2 Reliability and validity

When a study is being conducted the authors’ need to always take the dependability and the validity of the material bases into consideration. As said by Lewis et al. (2003) the level-headedness of the data concerns if the empirical detections are what they seem to be. The dependability is to what level the methodology of gathering data will be reliable and reliable.

When creating use of a methodology where interviews are being conducted with specific individuals, it is very difficult to achieve similar interviews at a later time. As the researcher was present with all interviews the risk of misunderstanding was removed, which upturns the dependability of the thesis. Additional, the researcher used a semi-structured procedure of interviews in which he had delivered the questions to the applicants in advance, which need to make it likely to make a comparable study in the future with results that are similar.

On the other hand, while doing the interviews follow-up comments and questions that are based on the responses that have occurred, which may be looked at as hard to duplicate in a future study. Most of the questions have been given responses that are different by the interviewees that were depending on their personal interest and experience. Some of the respondents have replied to some of the questions that are very detailed while others have replied with much less information. The researcher has measured the fact that the applicants replied the queries to different extents, and that they, in the researchers opinion, retain dissimilar amounts of knowledge and involvement when it comes down to risk management in hedge funds.

Additionally, there is an unceasing growth that is in the market in positions of how risk management is done and principles tend to become severer as time goes by. This decreases the likelihood of attaining the same responses if a future study was accompanied. One would have to understand that the fund managers are signifying the hedge fund industry from a managerial viewpoint, which means that their opinions has been affected by their specialized parts and therefore cannot be seen as purely objective. Because the interviewees are not nameless in the thesis, this might also affect their responses as they signify their individual organizations.

The validity can be probed because there were only a few interviews that were done in London area but since this is where most British hedge funds are positioned, we believe that deductions made are lawful for the entire of Britain. We further believe that even with four interviews and one answered questionnaire from Toscafund, the outcomes of the thesis needs to be given a legal picture of realism. All the applicants own a lot of years of solid knowledge with risk management inside the hedge fund business.

Bell and Bryman (2005) make the argument that when some one indicates the validity in a thesis it is connected to whether the response to a definite question is replicating the reply to the questions that are being intended to give. Further one should regulate if the answers are similar as the authors’ could have anticipated. The connotation of this is that it is vital that the questions are being designed well and properly formulated and therefore puts out a high validity. The questionnaire (Appendix 1 & 2), that had been designed by th e researcher input from his tutors, is founded on secondary data taken from the theoretical outline. This method of getting queries of greater excellence was done to be competent to obtain a higher dependability and validity in the researcher’s thesis. The meaning was to be able to reply to the research queries and determination in the best likely way. We trust that the questionnaire is well expressed, have replied my research questions, encounter the researcher’s purpose and provided a conclusion that is valid.

Chapter Three Methodology

CHAPTER FOUR: INTERVIEWS AND ANALYSIS

4.1 INTRODUCTION

The previous chapter basically just dealt with the methodology and research methods that are being utilized in this study. The data that was gathered by means of interviews and document examination are now examined and interpreted.

The information that is provided by the respondents are measured to proprietary and are to be very confidential. The empirical discoveries from all five respondents are offered in a masked arrangement as trails: respondent 1, respondent 2, respondent 3, respondent 4 and respondent 5.

By categorizing the data as stated by the research questions, the main themes that are going on during the analysis process had become obvious. By using a compound data source that is more exact themes and patterns that have emerged than if a unitary basis had been utilized. Categorization basic the data reduction procedure and assisted the researcher to see which thoughts kept on happening.

In this section the researcher gives a brief description of those that had participated in the interview with general regarding the hedge funds or administrations they are working for. All the information that has been presented here was gotten through the interview itself and all are anonymous.

The five people interviewed were:

Executive Chairman: Eric Bateman Qualifications: B.Com, MBA Hedge Fund experience: 30 years

He has a lot of years of experience in the investment industry through investment research, investment management and in more previous years as an executive director of a quite a few of leading British Investment groups. He has been involved in the discussions and drafting of the Regulations for the British Hedge Fund industry.

Director: Tony Benns

Qualifications:

He had a very long career in banking and that comprises business banking, and has likewise spent an amount of years as an independent auditor, he supervises Treasury.

Head: Fund Accounting: Jonah Johnson

Credentials: B.Compt (Hons), London Hedge Fund experience: 8 years

He has worked in the financial services all the way since 1994 having first gotten his exposure at Firstcorp then went on to other places like Franklin Templeton NIB and then went to work at the Nedcor Wealth Management.

Manager: Joshua Jones Group Risk and Compliance Qualifications: BA, LLB.

HedgeFund experience: 5 years

Since 1986, Jones has been working in the insurance and asset management industries. In addition to fund administration, he has been involved in remuneration structuring and pension fund accounting. He is a member of the Compliance Institute of South Africa.

Founding partner: Herbert Smith

Hedge Fund experience: 10 Years

Smith has worked in the South America financial markets since 1987. He has also worked on the purchase and sell side e & exclusive trading desks, in the money, bond, fairness & derivatives marketplaces. He has aided as Deputy Chairman of the South American Institution of Financial Markets, and also on the board of the Hedge Fund Association of London; He was an establishing worker at a bank startup in 1987, originated an independent member in 1982.

4.2 Questions

In order for things to be a little simpler for the reader the parts 4.2.1-4.2.4 are going utilized in a way to answer the first research question:

“How do hedge fund managers observe risk in their portfolios and how are they able to manage it?”

Section 4.2.5-4.2.6 is going to assist in aiding in responding to the second research Question:

“How do hedge fund managers create their portfolios by way of respects to risk management?”

Lastly sections 4.2.7-4.2.9 will be utilized to be able to provide a reply to the third research question:

“How is risk measurement being utilized when it comes down to risk management and how effective are they when applied to hedge funds?”

4.2.1 The definition and nature of risk

It is vital in order to distinguish among each manager’s meanings of risk because this will be able to provide a basis for understanding how they are perceiving the concept of risk. The description of the nature of risk will further influence the manager’s view on the controllability and description of risk.

Empirical findings

Smith, Batemen and Benns makes statement that risk is a concept that is exclusive, an all of this depends on the situation that is at hand. They go on to further make the point of what really consists of different risk-components for instance operational risk and financial risk. It is vital to recognize how all of these mechanisms effect total risk in addition as the features of these constituents to be able to get an impression of what risk is all about . Smith puts out a general definition of risk as that it can be looked at as the likelihood of an unwelcome event together with the properties of that occasion. Smith mentions that risk can be partly measured but that guiding the total risk of a fund has its boundaries, which is something that everyone has to recognize. The aim for the restriction is that risk measurement and therefore management is founded on historical statistics and for the reason that of this one must comprehend the problems in bulging future standards.

Jones, describes the concept of risk with the explanation in a different manner. He believes that the do not always have to be that big of a deal. He takes more of a laid back approach to the answer. Jones makes that point that risk can be controlled to a certain extent and that risk at times can be the fact of losing some money that a company cannot afford to lose.

Johnson, and Benns does not provide a strong description of risk during the interview; what they chose to do process of enumerating the risk and all of the risk measures that are being utilized in the fund. The risk measurement stages that are being used in the funds are tremendously complex and they track and measure various risk features on thousands of various trades and merchandises. RPM mentions that the most important risk that they are facing in the fund is the day-to-day expense risk, which is fairly dissimilar to the general risks that are being faced by predictable hedge funds.

As an alternative of defining risk, Benns distinguished among various forms of risks. The ones that are talked about, and that establishes the main threat to the fund, are marketplace risk, liquidness risk and money risk. Entire risk would then be seen as the total of all of these sections. Further Benns highlights that Thyra Hedge is a hedge fund that is low risk and that the view on risk regarding the fund is just the loss of capital and extreme instability.

4.2.2 The justification of risk management

Empirical findings

According to Smith all the risk management procedures bring worth to the hedge funds. It is vital to highlight the significance of capable persons that are involved in the hedge fund but in mixture with a staff that is competent, risk management will bring worth to the fund and provide it an benefit relative to its participants. Smith further mentions that by having a well-industrialized risk management system the hedge fund will not become cost-effective as such, it is vital that the managers are accomplished, knowledgeable and that they are concentrating on the commercial field in which they are specialists.

According to Jones the significance of proper risk management for hedge funds is going up quickly after the market crash that took place in 2008. Not only was it obvious that a lot of strategies and tools utilized for and by hedge funds throughout this period were not able to seize and regulate risks in a wanted style, the publics’ opinion concerning alternative savings and particularly hedge funds went down.

Benns makes the arguement that as their hedge fund, Toscafund, keeps the emphasis on the TMT-segment, risk management is much more significant. The TMT-sector is considered as extremely unstable and the doubt concerning businesses is high. This is mostly in reply to the doubt about technical advances, copyrights and the attendance of a great amount of contestants in the market.

Johnson makes the point that when a stockholder has selected to capitalize his wealth in a hedge fund it is under the principle that a confident risk-level will be preserved. As approximately all hedge funds entice new clienteles by publicity the risk-levels and management methods engaged by the fund it is energetic that the funds endure to function within these heights. They last by mentioning that it is similarly significant that other risks are organized by the funds and not just the monetary risks.

4.2.3 The utilized risk management strategies

Empirical findings

According to Bateman, risk management is current in every phase of their investment and administration procedure. Their investment procedure contains of a very detailed analysis and calculation of the measured establishment, both the firm’s essentials and the sure marketplace is projected. They regularly are matching the controls with actual visits to the likely businesses in order to get differentiate the standards and the management. After viewing this thorough analysis and observing all various types of the firm and its market sector the likely developments from the asset is related to the additional risks that would enter their fund.

Smith makes the point that the approach of picking stock to the investment procedure is a significant share of their risk management and mentions that it is smart to know what you are putting your money in. To further achieve the possibilities in the portfolio and to lessening the beta-risk, most of them hedge their locations by selling short and by expending outlooks on the stock exchange of other nations. As said by Benns a well differentiated portfolio is one of the important mechanisms to correct risk management and they purpose to keep 12-25 long and short situations in their assortment at all times. Neither of these locations is permitted to quantity for in excess of 7-8% of entire portfolio principal. To diminish the organizational risk and to demonstrate to stockholders that inducements are allied, the managers of Adrigo have capitalized a large quantity of their own currency into the asset and they are prohibited to possess any stock external of the fund.

Jones states that adjusting liquidity risk is becoming a progressively significant section of risk management for hedge funds and highlights how problematic this task has to turn in to become. Liquidity risk is principally an issue for fund of assets but it is still current in a normal hedge fund. It is vital to create forecasts of upcoming cash activities in the fund to be capable to evade liquidity disparities. As said by Smith, currency risk is an additional subject matter that has been getting augmented consideration in the hedge fund manufacturing. To counter money risk in the portfolio, positions that are deemed as risky because of doubts about money standards are hedged using a variety of dissimilar kinds of choices. Bateman decreases the marketplace risk in its portfolio by means of future agreements to hedge uncertain locations. Further the portfolio contains of 12-25 long locations and 5-6 short positions to expand the risk that is among numerous dissimilar markets and productions. These situations are arrived merely after the corporations have been expansively scrutinized and their possessions on the portfolio have been measured.

Chapter Four Interview and Analysis extension knowing the whole portfolio, the managers are able to predict how the portfolio will behave in certain market conditions and trends. It can be argued that fundamental analysis and due diligence is the foundation of efficient risk management as subsequent actions and strategies are based on the companies and, more specifically, the composition of the portfolio.

4.2.4 The difference among the measurement and the management of risk

Empirical findings

Regarding the difference among the management and the measurement of risk a lot of the hedge fund managers appeared to be on the same page. Bateman, Smith & Jones all contracted on the description of risk measurement as the quantification of present risk heights and the intention of these variables while risk management was merely the resulting custom of these variables to influence and control present risk levels.

Johnson delivered a comparable difference among them by affirming that the dimension of risk provided you with a stagnant depiction of current risk stages whereas risk management was more functioning and strained to switch risk by exploit, i.e. investment choices or other trading actions. They highlight the position of employing in cooperation mechanisms to be able to manage a hedge fund efficiently.

As stated by Benns, the quantification and control of risk variables is a constituent of the superior process, which is risk management. This makes the point that the two are tangled and that risk measurement is merely one section of risk management.

4.2.5 The management of risk in the construction process

Empirical findings

Smith makes the point that the most vital part when putting together a portfolio is not to have too many things going on in the same area, henceforth diversification is actually significant. Smith contends that they never wish to capitalize more than 8-9% of entire fund capital in all location of the hedge fund to be competent in protecting the portfolio from disappointment in circumstance of one device acting unwell.

Jones put a lot of stress on that they have tremendously extensive rules in their hedge fund portfolio building. They contend that their strategies are much wider than needed. The chief motive for this is that Jones needs to contribute their fund managers the capability to have the liberty to do whatsoever they want when constructing a portfolio.

Toscafund is very cautious and precise in their risk management when constructing their portfolios. An in-depth analysis is done on the potential reserves. Each tool that is measured is broken down in order to escalate their performance and what risk management that has to be completed in order to bound the hazards in the best probable method. Toscafund investment study also systematically analyses the different bond-, market- and product associates of the stately fund.

4.2.7 The risk variables used

Empirical findings

Smith displays merely the Sharpe ratio besides to the compulsory Standard Deviation (SD), which is required by Toscafund every month. For the reason that of that Smith is comparatively small since they do not analyze risk variables for instance ES/CVaR VaR, or Beta in their portfolios ever since they are not possessing sufficient possessions to compute them. Adrigo has an exterior back-office that grips all of their controls for them.

Jones is utilizing Beta, Sharpe and VaR, proportion as their risk capacities in totaling of those demanded from Toscafund. Jones is not making the use of ES/CVaR in the any of their risk variables. Jones also has an exterior back-office, which does all of all the intentions that are needed and connects them to Jones and Toscafund.

Toscafund is putting much of their focus on risk measurement as an essential part of their risk management. Since there is an advanced risk management IT method, which took over a decade to develop, RPM is capable of making a 200-page credit of risk variables daily to their dissimilar savers who occasionally demand them. These comprise all of the risk capacities we have investigated roughly and even more.

Johnson computes everyone of the risk variables that the researcher asked about counting ES/CVaR, VaR, Beta and Share ratio. As one of the humblest risk variables Johnson utilizes VaR and it has been utilzed in one way or another all over the organizations history.

CHAPTER FIVE: FINDINGS AND RECOMMENDATIONS

5.1 The definition and nature of risk

Analysis

In agreement with the theoretical outline on the definition of risk, those that took part in the study really had a hard time to describing what risk is. This vagueness regarding what risk is appears to be current in all of the research that has been done on the subject and a lot of times researchers, for instance Parker and Warsafer (2000), trust on giving examples in place of a clear-cut meaning of what risk is. In actual fact, Jaeger (2000) reinforces this disagreement by given that the statement that efforts to learn a single meaning of risk are guaranteed to be unsuccessful as ones view on risk is very subjective and therefore the meanings can differ a lot. The researcher findings make the suggestion that what Jaeger (2000) talks about is actually true as none of the members achieved to decide on a sole definition. Smith and Jones followed the direction which was taken by Parker and Warsafer (2000) and gave instances of life events that were real, which would bring highpoints to what risk was to these managers. Bateman and Johnson were as an alternative rapid to change the issue from describing risk to the procedure of counting it and the mechanisms of risk instead. It is obvious to derive an accepting of what risk is to these managers by the technique they undertook the issue of defining risk.the researcher believe that Benns delivers the best instance of this. This hedge fund is tremendously concentrated on counting risk and analyzes an abundance of risk variables, therefore it was no astonishment that they removed the conversation to the procedure of quantifying risk in place of describing the idea of risk. The researcher finds that a person’s interpretation on risk is extremely swayed by the way which with the hedge fund is being managed. Johnson additionally demonstrates this statement as they live carefully with their fund and have considerable calculations of private capital capitalized in the fund. Their instance of what risk is was that it was ones aptitude to be able to have a good sleep at night. This meaning is extremely swayed by the smartness of management engaged by the fund.

5.2 The justification of risk management

Analysis

While evaluating the empirical framework the researcher did observe that everyone of the hedge funds, which we had been interviewed, discovered risk management to be a very vital section of the management procedure. The researcher discovered that in agreement with the philosophies of Ineichen (2003), which makes the point that the a lot of lucrative hedge funds reliably shine because of operational risk management; the interviewees thought that risk management brings worth to the hedge funds and provides them an economical benefit. Notable answers concerning this subject are accessible by Adrigo, which mentions that deprived of risk management there is no worth in hedge funds. The connotation of this is that the benefit of capitalizing in hedge funds associated to regular investment ways, for instance mutual funds, remains in the operation of risk management policies and asset gears not obtainable to the other assets. Bateman gave a similar clarification to this when they quantified that the chief determination of hedge funds was to basically counter the risk. Jones also appeared to understand the position of risk management and decided that a lot of the additional worth of hedge funds came from actual risk management. This philosophy that well-organized risk management would enhance worth to the fund is dependable with the theory which was presented by White (1995) which makes the point that management of hedge funds is capable bringing worth to the fund by lessening dead weight loss because of a more effective procedure of money.

5.3 The utilized risk management strategies

Analysis

While the researcher was giving an analysis of his empirical findings he took a notice in the fact that some similarities, which were reliably appearing among the interviewed managers that were interviewed.

The first thing that the researcher took notice of was that most of everyone of that all of the managers agree regarding the position of due thoroughness and important analysis regarding new savings for an well-organized risk management. This is not astonishing as it is continuously key to distinguish what type of businesses that you are capitalizing in and it is correspondingly significant to examine and scheme what the future growths in the market will become. By really understanding the businesses, and by postponement recognizing the entire portfolio, the managers are capable to forecast how the portfolio will achieve in convinced market circumstances and tendencies. It can be contended that important analysis and due assiduousness is the basis of well-organized risk management as following movements and plans are grounded on the corporations and, more exactly, the arrangement of the portfolio.

5.4The difference among the measurement and the management of risk

Analysis

The researcher’s empirical findings here make the suggestion that the managers of the hedge funds create similar dissimilarities among the management and the measurement of risk as one another.

Benns distinction is maybe the one that condenses it best by affirming that the two are entwined and that risk measurement is merely one constituent of risk management. The researcher empirical findings in this unit does appear to bring support to the differences obtainable in the theoretical framework by Jaeger (2003) where he made the point that risk measurement is vital area of risk management but likewise contends that the dimension of risk in itself is a submissive action while risk management suggests action and action.

5.5 The management of risk in the construction process

Analysis

As stated in preceding units, all the managers highlight the position of rigorous due meticulousness investigation and the position of a well-expanded portfolio. Another issue, which seems to be reliably obtainable during the course of the interviews, is the essential for some boundaries and limits within the fund. Although the cruelties of the bounds fluctuate extensively some reliabilities can be perceived.

The first constancy that the researcher noticed is the choice and extent of market situations. The administrators of the hedge funds have strategies set which shapes how a lot of the positions need to be reserved at all times as well as boundaries as to how big any one of these situations are endorsed to be in the study. All questioned hedge fund managers quantified a choice of asset situations, which it attempts to hold at all times to keep expanded. Further Smith specified that no one situation is allowable to surpass 8-9% of entire portfolio money while Jones detailed that they strained to keep all locations below the 10% of entire portfolio principal but that this was more of an advice than a limit and exclusions happened.

The other constancy the researcher discovered is the geographical limitations or attention realized in the funds and the incidence of business and marketplace limitations in some of them. The hedge funds achieved by Bateman, Jones & Johnson have an worldwide emphasis and trade in all marketplaces but these funds typically have other limitations realized which touches trading to some gradation. The researcher does note that Bateman presently accomplishes four dissimilar hedge funds with dissimilar limitations that all have an global emphasis. Both Toscafund, which is managed by Smith, and TMT total profit, which is controlled by Jones, are TMT-absorbed hedge funds and therefore are limited to capitalize in simply the TMT- markets but deprived of regards to the businesses’ topographical source. Benns merely capitalizes in stocks listed in the worldwide stock markets.

5.6 The risk variables used

Analysis

In this examination we will associate the fund managers’ inclinations when it comes to the exploited risk variables.

The tendency appears to be that the bigger business creates a use of more risk variables and the other way around. Benns and Bateman utilize all the different risk variables to amount risk, which is done by forecasters from firms of their own. Jones have admission to a lot of them through their outside back-office. Bateman, also being the minimum firm of the applicants, has the smallest admission to risk variables by means of their external back-office much on account of the limited quantity of capitals that is put into this part of their risk management.

Chapter Five Findings and Recommendations

CHAPTER SIX: CONCLUSION

In the finishing chapter the conclusions of the thesis is presented that comes from the problem discussion, which is built upon the theoretical framework, the collected empirical findings and the analysis. The chapter starts with understanding the criteria’s for a well-functioning risk management in hedge funds, how they are best constructed with regards to risk management and the validity of risk measurements when it comes to hedge funds. The chapter is finished with suggestions for further studies.

In the previous chapter of four, the outcomes of the empirical study were obtainable and examined. The results gotten were equated with the contemporary literature that had been reviewed in chapter two of this study.

In this chapter, the entire study is summarized and the chief outcomes are connected back to the essential issues that are being addressed originally. Recommendations will also be made that are based on the foremost discoveries of the research and will be followed by chances for further research. The chapter then finishes out with a chapter summary.

The concluding section of the thesis will present the conclusion and state the purpose from chapter 1 to remind the reader and make it easier for him or her to be able to fully understand the conclusion.

“The purpose of this thesis is to increase the knowledge of how hedge fund managers perceive and manage different types of risk in hedge funds with respects to risk management. The researcher also desired to examine how risk capacities are used when it comes to risk management and how effective they are when put to hedge funds.”

The aim of the study was to reply to the resolution that was stated through three different research questions. The first research question the researcher wanted to answer is:

“How do hedge fund managers perceive risk in their portfolios and then how are they able to manage it?”

The researcher came to the conclusion that when it comes to the description of risk the descriptions were abstruse and varied greatly among the hedge fund managers. Different was that the hedge funds, which centered on quantifications and designs, observed these variables as risk although the other reserves saw risk as something that was abstract. The researcher had discovered that the description of risk appears to be extremely predisposed by the flair of management engaged by the fund. Bearing in mind the subject as a whole, the manager’s separate meaning of risk is of little significance to the risk management procedure of the hedge fund. The risk that is in the hedge funds was as an alternative managed otherwise contingent on manager’s view concerning the nature and controllability of risk.

The researcher discovered that all managers appeared to have come to an agreement on that risk was manageable to some extent but that there are continuously restrictions within the approaches and that an improbability feature will at all times be current in the portfolio. The agreement was that it is significant to screen your risk variables and to have a lively risk management. It is though likewise important to understand that these variables will not arrest the total risk current in the portfolio. As a result it can be specified that the fund managers have to utilized their involvement and information in combination with an active risk management to run an well-organized hedge fund.

The researcher makes the conclusion that within the hedge fund industry, what differentiates a fruitful fund from a less cost-effective one can, to some extent, be clarified by the efficiency of the risk management system that is utilized. A lot of the hedge fund managers make the argue that controlling risk is the chief goal of a hedge fund and the motive as to why the business was shaped. The researcher discovered that all the managers that had been interviewed made the agreement concerning the position of due carefulness and rigorous examination that concerns new investments in the portfolio. The researcher has to emphasize that this is not just regarding the individual asset but also the influence these reserves would have on the current portfolio. The researcher therefore came to the conclusion that fundamental examination and due industry is the foundation of well-organized risk management as following actions and policies are based on the businesses and, more exactly, the arrangement of the portfolio.

The researcher also discovered that another feature of risk management, which was thought of as actual importance in the hedge fund business, is the change of possessions. Despite the fact the practicality of expanding across markets, businesses and asset courses are decided upon there appears to be some differences regarding the amount of properties that are needed for a well-diversified portfolio. This appears to be in agreement with the theories obtainable by Lhabitant and Learned (2002) which mentions that one has to reflect issues for instance market circumstances, business costs and individual characteristics of the hedge funds to regulate the optimal amount of locations. The researcher also discovered that hedge fund managers most of the time do rely on hedging plans to separate and control unwelcome risks in their portfolios.

Another trend found from our interviews is that more attention is focused towards the people behind the companies and the funds invested in. Some hedge fund managers even state that their biggest competitive advantage consists of their ability to make personal visits to companies and therefore appraise the people that are behind it. The researcher makes the decision that all managers understood the position of risk management, not only as an instrument to accomplish larger revenues but also as an inducement for stockholders to select their hedge fund over others.

The second research question is:

“How do hedge fund managers build their portfolios with respects to risk management?”

The researcher came to the conclusion that hedge fund managers have this belief that there is a need for restrictions and limits within their funds. While the limits and restrictions that were enforced differed widely between hedge funds, it could be seen that similar guidelines were applied concerning the size of individual investments, the number of positions entered and the geographical and industrial focus of the hedge fund. The fact that nearly all hedge funds had enforced limits within these areas should come as no surprise; as the importance to allocate capital and thus risk towards areas of expertise is both intuitive and supported by theoretical framework such as that presented by Ezra et al. (1991). It can be argued that by enforcing and following restrictions and limits, such as the ones stated earlier, the fund has established a foundation to build its risk management and investment philosophy upon.

We found a significant difference between hedge funds controlling a big amount of capital and smaller ones with regards to the degree of freedom for its managers and the trading process implemented in the hedge fund. While the larger hedge funds relied on strict enforcement of their rules and guidelines and had a high degree of hierarchy, the managers of the smaller hedge funds seemed to have a higher degree of freedom and a less complicated investment process. The consequence of this is that the managers of smaller hedge funds are allowed to follow their opinions and trade more freely, while the structure of larger hedge funds prevents mistakes and unthoughtful investments. Both of these structures have their pros and cons and to say that one is better than the other would be merely a speculation.

The researcher concludes that all of the interviewed hedge fund managers realized the importance of knowing how your portfolio will behave in different market conditions and emphasized the need to understand how the portfolio is constructed. While they all agreed on the importance of this knowledge they disagreed on the method to achieve it. While the smaller funds seemed to believe that the most efficient way to get to know your portfolio was to monitor its performance closely and to learn from market events and mistakes, the larger funds used a combination of both scenario analysis and stress tests to analyze the characteristics of their portfolios. There seems to be an agreement upon limitations in these stress tests and scenario analysis in that they are not able to capture market crashes.

5.1 Further studies

During the course of the writing of this paper the researcher has discovered a lot of ideas and has utilized them as propositions for further research in the places of risk management and risk measurement in the interior hedge funds.

This study has been achieved with a restricted number of companies. The researcher believes that it would be thought-provoking to contain more hedge fund managers in a new study in order to receive an even profounder understanding of their interpretation on risk management in hedge funds. Ever since the limitations, boundaries, tools and methods exploited in the hedge fund business are repeatedly developing the researcher suggest that a new study would need to be done couple years down the road in order to detect if there are any key alterations from the outcome of this thesis.

Most of the hedge fund managers interviewed in this thesis did frequently mention that the most important thing is to live with the hedge fund, apply common sense to the risk variables and that personal experience is of great value. It would be interesting to further examine how the hedge fund managers, to be able to manage the risk, actually apply this knowledge. This could perhaps be done through following a hedge fund manager more closely for some time to fully be able to comprehend how he or she uses their knowledge and experience to manage the risk. This is because of that there might exist differences between what a manager says during an interview and what they actually do in real life.

Most hedge fund managers and researchers are arguing that the risk variables used in the hedge fund industry are not appropriate. It would be interesting, if resources and knowledge were available, to conduct a mathematical research where the risk variables were extensively examined. After this research has been conducted one can, to some extent, understand how valid the different risk variables actually are, hence decide their appropriateness for the hedge fund industry.

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Appendix 1

Questions that were utilized during the four interviews that were conducted

Introduction

1. Describe who you are.

2. Describe the your hedge fund manager.

How do hedge fund managers perceive risk in their portfolio and how do they manage it?

3. What way to you define risk?

4. Do you think it is possible to control risk?

5. What do you perceive of risk management, is it imperative? Why?

6. How do you manage the diverse risks that are in your hedge fund?

7. Does risk management bring any value to the hedge fund?

8. What is the variance that goes on among risk management and the measurement of risk?

How do hedge fund managers build their portfolio with regards to risk management?

9. How was the hedge fund done when it comes down to the risk management? Do you have to go by certain given guidelines?

10. Have you performed situation examines/stress tests on the portfolio? Do you have written tactics for likely future proceedings?

How is risk measurements utilized when it comes down to risk management and how legal are they when put to hedge funds?

11. What risk measurements are being used in the hedge fund and how well do you believe that they are seizing the real risk in the portfolio? Do you use risk capacities for instance VAR, ES/CVAR, Beta, Sharpe ratio?

12. How do you utilize the risk measurements designed?

13. What is your estimation concerning normal deviation, once-a-month return and concentration risk, Are they sufficient to provide a passable picture of the risk in hedge funds?

14. The strategies utilized for risk management and risk measurement by hedge fund managers are the similar utilized in mutual funds. How valid do you think these risk strategies and risk measurements are when considering that hedge funds access more financial instruments and the dynamic character of hedge funds savings strategies?

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