Risk Management at Hedge Funds

Risk management is not always a distinct department at hedge funds. At small hedge funds, the principals or the trading group will monitor the risk; there are no specific risk personnel. Also, many hedge funds outsource their risk controls to third-party vendors that specialize in providing this service to corporations, hedge funds, mutual funds and other firms. And many investment banks also provide risk management as a value-added service through their prime broker departments (described in Chapter 11). But at large funds, there is usually a group with the sole responsibility of monitoring and reducing risk. The risk management department proactively monitors each hedge fund, using either propriety or vendor-purchased tools and methodologies for risk management. Based on their analysis, risk professionals implement strategies to either remove or reduce the risk.

Fund of funds are known to have very large risk teams for two reasons: 1) by nature, funds of funds deal with a large variety of securities and 2) the risk group plays a large role in alleviating concerns of existing and potential investors.

Risk Associate

Risk associates play a supporting role in the risk department. A thorough understanding of a variety of trading products (i.e., options, fixed income, mortgage backed securities, swaptions), options risks (i.e., delta, gamma, Vega, rho, and theta; see sidebar on p. 81) and strong analytical skills are required. The daily job duties include, but are not limited to, maintaining value at risk (VAR) data, back-testing and stress-testing securities within a portfolio and reporting the analyzed data to senior risk management.

Risk professionals also sometimes interact with clients (investors). Larger hedge funds have a designated investor relations employee whose sole responsibility is to field calls from investors, but at smaller funds, investors may call the risk group directly to state and address any risk concerns. A strong risk monitoring system is important to investors, as it reduces the likelihood of error and losses. Investors thus are keen on speaking with the risk team to alleviate their concerns. As discussed, many investment banks offer risk capabilities through their prime brokerage departments. At a prime broker, risk associate will perform the same duties as at a hedge funds, except he will be monitoring risk for several hedge funds that are prime broker clients.

The risk associate position requires a minimum of a bachelor's degree and a few years of relevant experience. This position pays from $50K to $70K depending on geographic location, previous experience, education skills and size of the corporation.