Managing Hedge Fund Risk and Financing: Adapting to a New Era

Hedge funds experienced a new challenge during the recent financial crisis: the simultaneous collapse of major financial institutions that were their trading counterparties and service providers, fundamental and systemic increases in market volatility and illiquidity which led to mark to market losses and increased demands for margin from their creditors, and lastly unrelenting demands from investors to redeem their hedge fund investments. Many hedge funds were unprepared for the maelstrom that engulfed them and many have failed or been forced to close due to resulting poor performance. This book encapsulates the lessons learned from the recent crisis and advises hedge fund managers and CFOs how to manage the risk of their investment strategies and structure relationships to best insulate their firms and investors from failure of financial counterparties so that their funds can remain free to take full advantage of opportunities presented by financial crises.

Risk management and maintaining funding liquidity are critical to differentiating a fund’s performance in a crisis. Avoidance of losses in the fund’s investment portfolio via effective risk management is only part of the solution. Having the ability to maintain or increase leverage and liquidity due to having negotiated binding lock ups and committed facilities with your prime brokers, and matching portfolio liquidity with potential investors redemption demands are also critical to maintaining a funds ability to opportunistically profit from a crisis.

1. Introduction

a. Analysis of Hedge fund performance 2006-2009

b. Characterization of Successful Hedge Funds

c. Characterization of Failing Hedge Funds

2. Overview of Primary Hedge Fund Strategies

a. Macro

b. Equity Long Short

c. Emerging Markets

d. Commodities

e. CB Arbitrage

f. Event Arbitrage

g. Fixed Income (CDS/Bonds, Relative Value, Distressed Debt)

3. Risk Management by Strategy

a. Macro

b. Equity Long Short

c. Emerging Markets

d. Commodities

e. CB Arbitrage

f. Event Arbitrage

g. Fixed Income (CDS/Bonds, Relative Value, Distressed Debt)

4. Overview of Hedge Fund Stakeholders and Contracts

a. Investors – Investment Agreement

i. Gates

ii. Liquidating Trusts

iii. Side Pockets

iv. Multiple Share Classes

b. Prime Brokers-

i. ISDA

ii. Prime Brokerage Agreements

iii. Lock Ups

iv. Committed Facilities

v. Transparency and Disclosure

5. Asset Liability Mismatches and Management

a. Funding Liquidity vs. Asset Liquidity

b. Increased Calls for Margin from Prime Brokers

c. Increased Demand for Redemptions from Investors

d. Asset Liquidity and ability to meet margin calls and finance redemptions

6. Counterparty Risk Management

a. Counterparty Credit Risk

i. Prime Broker

1. Rehypthecation

2. US vs. European Regulatory Protection

3. Tri Party Custodian Agreements

4. Third Party Custodian Agreements

ii. Custodian

iii. Administrator

b. Counterparty Operational Failure

i. Prime Broker

1. Valuation Disputes

2. Erroneous Margin Calls

3. Trade Confirmations

4. Administrative Errors

7. Conclusion

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