How to tell if your hedge fund is misbehaving

June 22, 2009

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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