There are many different strategies used by hedge fund managers to deal with risk. Increasingly, since institutional investors are considering putting their money into a hedge fund, risk management is being regarded as an integral part of the process. According to a survey conducted by Prmia and SunGard APT, more than 80 percent of hedge funds feel risk management will become more crucial to raising assets this year. This suggests that a long-term solution for hedge fund risk management should be seen as “an essential function.”
Currently, hedge funds generally focus on short-term downside risk measures, as opposed to statistical measurements that have been used in the past such as volatility. Thus it is probably a good idea for hedge funds to engage more heavily in stress testing as that is a more concrete way of dealing with declining performance. It is thus better for the hedge fund industry to engage less in backward-looking risk analytics and more in stress testing.
In other words, what needs to happen is that the investment process has to include an integration of risk management as currently this is one of the primary challenge of hedge fund managers. Another issue for hedge funds to contend with is regulatory uncertainty which few believe has enhanced risk processes.
As well, given that Europe has recently encountered the Alternative Investment Fund Managers (AIFM) directive, hedge funds there are being pushed to a uniform approach to risk management and measurement. In turn, they are becoming more like retail Ucits funds in reporting to regulators and investors.