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Incompetence … and Incompetence Again Print E-mail
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Incompetence … and Incompetence Again
Incompetence (contd.)
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The unique hedge fund risk management problems deriving from the numerous factors like non-normality of their distributions of returns, bizarre hedge fund indices and the data biases are not new. One may easily find hundreds of articles and deep researches on the subject as well as a few proven frameworks offering feasible solutions by enhancing the commonly used risk metrics. While these frameworks may vary in the suggested models and their implementation, they all have one thing in common: the mean-variance risk valuation methodology is hardly applicable to hedge funds and, to an even greater extent, to fund-of-funds instruments.
Still, it does not seem these voices are being heard by the financial institutions. According to our statistics based on the real contacts with hundreds of investment managers, over 85% of the total number of one hundred and fifty six recipients still widely use the classic mean/standard deviation metrics for the hedge fund risk assessment combined with the “proven” Tactical Asset Allocation as a way of constructing hedge fund portfolios.
Surprisingly, no one has ever been really arguing the clear facts of inapplicability of the currently used frameworks. You may ask then, why not to incorporate something more advanced and appropriate. Well, among many given excuses, there are a few most typical and funny ones:
  • “our senior management will not understand this”;
  • “it would take years to approve a new framework”;
  • “we are not sure, if we need it at all… we are investing into real estate funds” - this wise statement was done, obviously, before collapsing the real estate market;
  • “we do not need a new quantitative framework; our investment process is based on knowing-our-managers due diligence, so we know what to expect from them.”
What is really needed for these people to learn something? A new LTCM? A new Enron? A global meltdown? Almost every month we are witnessing a new institutional fund collapse case. It has become a common habit to blame the subprime crisis for everything, for all the losses and defaults.

Though we cannot deny the negative role of the credit crisis and its global effect on overall fund performance, the most important factor driving the particular investment fund industry down is wild incompetence. Thus, managing a single fund strategy implies a high degree of professional expertise and, without doubts, a hands-on experience in trading, derivatives, hedging models etc. In contrast, managing a fund of investment funds often implies no expertise whatsoever. Just look at the real-world examples (the real names are not mentioned due to the obvious reasons):
  • A hundred million dollar fund of funds had been effectively managing by a former police officer (over 15 years in the forces) having only a few months accounting courses as a financial degree substitution;
  • A senior fund analyst holding a Bachelor of Arts degree in music;
  • A managing director and a Chief Investment Officer of a two-billion dollar fund having a Law Degree with the majors in the civil law and philology.
We could list plenty of similar examples clearly demonstrating the devastating trend in the industry: the professional skills do not seem to be mandatory in the investment funds. No wonder, all the funds proudly managed by the mentioned people successfully collapsed in 2007-2008. Guess what happened to all these “investment experts”. Nothing bad at all. They successfully moved to other top-grade financial institutions occupying high-status positions.
One may say these examples are the extreme cases and should not be taken seriously. Well, if the assets of two-billion dollars under management are not a serious case, take a look at the senior portfolio manager job requirements posted by an institutional investor with over sixty billion under management:
Relevant Experience Required: 1-5 years experience working as a professional in fields such as finance, portfolio management, accounting, law or engineering.
So, anyone with, at least, one-year experience in whatever fields would qualify for this job, i.e. manage a hedge fund portfolio of about 2% of total assets, i.e. over a billion dollars.
What is the conclusion of the whole story? Everyone can make their own conclusion, which fully depends on which side of the table one belongs to. Our own position should be clear enough.