Risk Management: Foundations for a Changing Financial World

CHAPTER 24

RISK MANAGEMENT FOR ALTERNATIVE INVESTMENT STRATEGIES^x

Leslie Rahl

A solid framework and an effective due diligence process are vital components of risk management for both traditional and alternative investments. Because many of the standard metrics used to manage traditional investments and measure risk do not work as well with alternative investments, managers must make many adjustments and be particularly cautious in choosing the proper analytical risk framework.

Although I have a strong quantitative background, I view risk as a real-world, not a mathematical, concept. Therefore, I will focus on risk and the issues associated with it, not equations. I define risk as the possibility of a bad outcome. For example, the most significant risk that pension fund managers face is probably reputational risk. No matter whether a pension plan sponsor, endowment, or foundation has done something brilliant or not so brilliant, that sponsor is most concerned about not seeing a front-page story in the Wall Street Journal about the fund’s investment failures.

I will discuss how best to avoid risk through the establishment of a solid risk management framework. It is important, however, to remember that the goal is to maximize risk-adjusted returns, not to eliminate risk! I will then focus on the primary goals of managing risk and return and address the due diligence process and a few of the most significant risks posed by alternative asset strategies. Problems with valuation and ...