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CAIA Level I: An Introduction to Core Topics in Alternative Investments, 2nd Edition by Hossein Kazemi, Keith H. Black, Donald R. Chambers, Mark J. P. Anson, CAIA Association

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CHAPTER 27

Risk Analysis

The accounts of hedge fund failures in Chapter 26 highlight the need for a thorough, clear understanding of the risks of a fund manager and the fund manager's risk management process. This chapter provides a framework for an asset allocator to assess the risk and risk management processes of a fund manager as a prelude to Chapter 28 on due diligence. The topics of this chapter are not specific to a particular investment strategy or style and generally apply to all fund structures, not just hedge funds.

Quantitative risk analysis is usually focused on historical analysis of past risk and return. However, very few hedge fund collapses can be predicted based on analysis of past returns alone. Recent research is providing evidence that a careful study of hedge fund failures and state-of-the-art due diligence processes can reduce the risk of allocating money to funds that experience catastrophic losses.

27.1 INVESTMENT STRATEGY RISKS

The analysis of the risk of a fund and the analysis of the risk management systems of a fund are inextricably linked with the investment strategy of the fund. A starting point for risk analysis is precise identification of the fund's investment strategy. Does the fund have an active and highly hedged strategy, such as a quantitative equity market-neutral fund, or does the fund have a more passive and unhedged strategy, such as a fund of funds?

A fund's investment strategy refers to the sets of objectives, principles, techniques, ...

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