How to tell if your hedge fund is misbehaving
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Hedge fund managers have very similar incentives to rogue traders: both of them, if they have a big loss, are going to be tempted to take a huge risk to get back into the black. If they succeed, they’re lauded as a genius; if they fail, they’re out of a job anyway.
Rick Bookstaber asks whether and how one might be able to tell if one’s hedge fund manager is taking the rogue-trader path; his answers are curiously unsatisfying. Really you need a professional looking under the hood, or ideally two — one looking at trading risks, and the other looking at operational risks. The chances that any given investor will be likely to uncover suspicious activity are so low that it’s probably not even worth trying; most likely they’d just end up with false confidence in the fund manager.
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How to tell if your hedge fund is misbehaving: it IS a hedge fund.
increase in leverage, a decrease in cash positions, increased monthly volatility of returns. Poorly correlated to any index (ala HFR) to which said hedge fund previously correlated well…of course asking the right questions all along helps
Intersting point though…something about the “2 and 20″ arrangement always bothered me, in particular as once-outsized returns diminished and marginal players flooded the biz.
The only way to tell is if they fail in their recovery gamble.