Editing Hedge fund (section)

==Risk==
For an investor who already holds large quantities of equities and bonds, investment in hedge funds may provide diversification and reduce the overall portfolio risk.<ref name=Davidoff>{{cite news |url=http://www.dealbook.nytimes.com/2009/09/17/to-reduce-hedge-fund-risk-let-everyone-in/ |title=To Reduce Hedge Fund Risk, Let Everyone In |last1=Davidoff |first1=Steven M. |date=17 September 2009 |work=The New York Times |access-date=27 March 2011 |archive-url=https://web.archive.org/web/20111228021244/http://dealbook.nytimes.com/2009/09/17/to-reduce-hedge-fund-risk-let-everyone-in/ |archive-date=28 December 2011 |url-status=dead |df=dmy-all }}</ref> Managers of hedge funds often aim to produce returns that are relatively [[Financial correlation|uncorrelated]] with market indices and are consistent with investors' desired level of risk.<ref name=Jones/><ref name=Lo>{{cite journal |last=Lo |first=Andrew |year=2001 |title=Risk Management for Hedge Funds: Introduction and Overview |journal=Financial Analysts Journal |volume=57 |issue=6 |pages=16–33 |url=http://www.alphasimplex.com/pdfs/RiskMgmtForHF.pdf |access-date=29 March 2011 |doi=10.2469/faj.v57.n6.2490 |archive-url=https://web.archive.org/web/20110627013040/http://www.alphasimplex.com/pdfs/RiskMgmtForHF.pdf |archive-date=27 June 2011 |url-status=dead |df=dmy-all |citeseerx=10.1.1.370.8177 |s2cid=218511194 }}</ref> While [[hedge (finance)|hedging]] can reduce some risks of an investment it usually increases others, such as [[operational risk]] and [[model risk]], so overall risk is reduced but cannot be eliminated. According to a report by the Hennessee Group, hedge funds were approximately one-third less volatile than the [[S&P 500]] between 1993 and 2010.<ref>{{cite web |url=http://www.thehedgefundjournal.com/news/2010/07/22/hennessee-protecting-capital-during-market-downturns.php |title=Hennessee: Protecting capital during market downturns |date=22 July 2010 |work=Hedge Fund Journal |access-date=30 March 2011 |archive-url=https://web.archive.org/web/20111006212623/http://www.thehedgefundjournal.com/news/2010/07/22/hennessee-protecting-capital-during-market-downturns.php |archive-date=6 October 2011 |url-status=live |df=dmy-all }}</ref>

===Risk management===
Investors in hedge funds are, in most countries, required to be qualified investors who are assumed to be aware of the [[investment risk]]s, and accept these risks because of the potential [[Rate of return|return]]s relative to those risks. Fund managers may employ extensive [[Financial risk management|risk management]] strategies in order to protect the fund and investors. According to the ''[[Financial Times]]'', "big hedge funds have some of the most sophisticated and exacting risk management practices anywhere in asset management."<ref name=Jones>{{cite news |title=Hedge funds: Stringent controls on losses and investment |first=Sam |last=Jones |url=http://www.ft.com/cms/s/0/5f253ab8-5371-11e0-86e6-00144feab49a.html#ixzz1ICqUvUmv |archive-url=https://ghostarchive.org/archive/20221210201217/https://www.ft.com/content/5f253ab8-5371-11e0-86e6-00144feab49a#ixzz1ICqUvUmv |archive-date=10 December 2022 |url-access=subscription |newspaper=Financial Times |date=21 March 2011 |access-date=30 March 2011 |url-status=live }}</ref> Hedge fund managers that hold a large number of investment positions for short periods are likely to have a particularly comprehensive risk management system in place, and it has become usual for funds to have independent risk officers who assess and manage risks but are not otherwise involved in trading.<ref name=Cassar/> A variety of different measurement techniques and models are used to estimate risk according to the fund's leverage, liquidity, and investment strategy.<ref name=Lo/><ref>Jaeger, Robert. A. (2003) Mcgraw Hill, All About Hedge Funds "A hedge fund is an actively managed investment fund"</ref> Non-normality of returns, volatility clustering and trends are not always accounted for by conventional risk measurement methodologies and so in addition to [[value at risk]] and similar measurements, funds may use integrated measures such as [[Drawdown (economics)|drawdowns]].<ref name="risk">{{Citation|title=López de Prado, M. and A. Peijan: Measuring Loss Potential of Hedge Fund Strategies| work=Journal of Alternative Investments|volume= 7|issue= 1 |pages= 7–31|year=2004|ssrn=641702| last1=Lopez De Prado| first1=Marcos| last2=Peijan| first2=Achim}}</ref>

In addition to assessing the market-related risks that may arise from an investment, investors commonly employ [[operational due diligence]] to assess the risk that error or [[fraud]] at a hedge fund might result in a loss to the investor. Considerations will include the organization and management of operations at the hedge fund manager, whether the investment strategy is likely to be sustainable, and the fund's ability to develop as a company.<ref>{{cite book |title=Hedge funds: crossing the institutional frontier |last=Jaffer |first=Sohail |year=2006 |publisher=Euromoney Books |isbn=978-1-84374-268-5 |pages=113–114}}</ref>

===Transparency, and regulatory considerations===
Since hedge funds are private entities and have few public [[Prospectus (finance)|disclosure]] requirements, this is sometimes perceived as a [[Transparency (market)|lack of transparency]].<ref name=IneichenRisk>{{cite book |title=Absolute Returns: the risks and opportunities of hedge fund investing |first=Alexander |last=Ineichen |year=2002 |publisher=John Wiley & Sons |isbn=978-0-471-25120-0 |pages=[https://archive.org/details/absolutereturnsr0000inei/page/441 441–444] |url=https://archive.org/details/absolutereturnsr0000inei/page/441 }}</ref> Another common perception of hedge funds is that their managers are not subject to as much regulatory oversight and/or [[registration statement|registration]] requirements as other financial investment managers, and more prone to manager-specific idiosyncratic risks such as style drifts, faulty operations, or fraud.<ref name=Jaeger/> New regulations introduced in the US and the EU as of 2010 required hedge fund managers to report more information, leading to greater transparency.<ref name=Chay>{{cite web |url=http://www.asiaone.com/Business/News/My%2BMoney/Story/A1Story20101129-249737.html |title=Call For Joint Effort to Protect Hedge Fund Business |first=Felda |last=Chay |date=27 November 2010 |work=The Business Times Singapore |publisher=Singapore Press Holdings |access-date=8 March 2011 |archive-url=https://web.archive.org/web/20101229035529/http://www.asiaone.com/Business/News/My%2BMoney/Story/A1Story20101129-249737.html |archive-date=29 December 2010 |url-status=dead |df=dmy-all }}</ref> In addition, investors, particularly institutional investors, are encouraging further developments in hedge fund risk management, both through internal practices and external regulatory requirements.<ref name=Jones/> The increasing influence of institutional investors has led to greater transparency: hedge funds increasingly provide information to investors including valuation methodology, positions, and leverage exposure.<ref>{{cite web |url=http://www.benefitscanada.com/investments/other-investments/institutional-investors-changing-the-rules-of-hedge-fund-investing-9126 |title=Institutional investors changing the rules of hedge fund investing |last1=White |first1=Jody |date=25 January 2010 |work=BenefitsCanada.com |access-date=30 March 2011 |archive-url=https://web.archive.org/web/20110728013636/http://www.benefitscanada.com/investments/other-investments/institutional-investors-changing-the-rules-of-hedge-fund-investing-9126 |archive-date=28 July 2011 |url-status=live |df=dmy-all }}</ref>

===Risks shared with other investment types===
Hedge funds share many of the same types of risk as other investment classes, including [[liquidity risk]] and manager risk.<ref name=Jaeger>{{cite web |url=http://www.math.ethz.ch/~embrechts/RM/jaeger.pdf |title=Risk Management for Hedge Fund Portfolios |first=Lars |last=Jaeger |date=28 April 2005 |work=Presentation at ETHZ [Eidgenössische Technische Hochschule Zürich] |publisher=Partners Group |access-date=17 March 2011 |archive-url=https://web.archive.org/web/20101122071129/http://www.math.ethz.ch/~embrechts/RM/jaeger.pdf |archive-date=22 November 2010 |url-status=dead |df=dmy-all }}</ref> [[Market liquidity|Liquidity]] refers to the degree to which an asset can be bought and sold or converted to cash; similar to private-equity funds, hedge funds employ a [[lock-up period]] during which an investor cannot remove money.<ref name="Coggan"/><ref name="What is a Hedge Fund"/> Manager risk refers to those risks which arise from the management of funds. As well as specific risks such as [[style drift]], which refers to a fund manager "drifting" away from an area of specific expertise, manager risk factors include [[valuation risk]], capacity risk, [[concentration risk]], and [[Leverage (finance)#Leverage and risk|leverage risk]].<ref name=IneichenRisk/> Valuation risk refers to the concern that the [[net asset value]] (NAV) of investments may be inaccurate;<ref name=Strachman>{{cite book |title=Fund of Funds Investing: A Roadmap to Portfolio Diversification |last1=Strachman |first1=Daniel A. |last2=Bookbinder |first2=Richard S. |year=2009 |publisher=John Wiley & Sons |isbn=978-0-470-25876-7 |pages=120–121}}</ref> capacity risk can arise from placing too much money into one particular strategy, which may lead to fund performance deterioration;<ref name=Avellanda>{{cite web |url=http://math.nyu.edu/faculty/avellane/HFCapacity.pdf |title=What is a Hedge Fund |last1=Avellanda |first1=Marco |last2=Besson |first2=Paul |publisher=New York University |access-date=28 March 2011 |archive-url=https://web.archive.org/web/20110526220222/http://math.nyu.edu/faculty/avellane/HFCapacity.pdf |archive-date=26 May 2011 |url-status=live |df=dmy-all }}</ref> and concentration risk may arise if a fund has too much exposure to a particular investment, sector, trading strategy, or group of [[Financial correlation|correlated]] funds.<ref name="Concentration Risk">{{cite web |url=http://knowledgebase.abcquant.com/index.php?option=com_kb&task=article&article=11 |title=Concentration Risk |year=2008 |publisher=Quant Risk Group |access-date=29 March 2011 |archive-url=https://web.archive.org/web/20110819124158/http://knowledgebase.abcquant.com/index.php?option=com_kb&task=article&article=11 |archive-date=19 August 2011 |url-status=dead |df=dmy-all }}</ref> These risks may be managed through defined controls over [[conflict of interest]],<ref name=Strachman/> restrictions on allocation of funds,<ref name=Avellanda/> and set exposure limits for strategies.<ref name="Concentration Risk"/>

Many investment funds use [[Leverage (finance)|leverage]], the practice of [[Debt|borrowing]] money, trading on [[margin (finance)|margin]], or using [[Derivative (finance)|derivatives]] to obtain market exposure in excess of that provided by investors' capital. Although leverage can increase potential returns, the opportunity for larger gains is weighed against the possibility of greater losses.<ref name="What is a Hedge Fund"/> Hedge funds employing leverage are likely to engage in extensive risk management practices.<ref name=Cassar>{{cite web |url=http://efmaefm.org/0EFMSYMPOSIUM/Toronto-2011/papers/Gerakos.pdf |title=How Do Hedge Funds Manage Portfolio Risk? |first1=Gavin |last1=Cassar |first2=Joseph |last2=Gerakos |work=EFM Symposium |publisher=European Financial Management Association |access-date=17 March 2011 |archive-url=https://web.archive.org/web/20110815125023/http://efmaefm.org/0EFMSYMPOSIUM/Toronto-2011/papers/Gerakos.pdf |archive-date=15 August 2011 |url-status=dead |df=dmy-all }}</ref><ref name=IneichenRisk/> In comparison with [[investment bank]]s, hedge fund leverage is relatively low; according to a [[National Bureau of Economic Research]] working paper, the average leverage for investment banks is 14.2, compared to between 1.5 and 2.5 for hedge funds.<ref name=AngGorovyy />

Some types of funds, including hedge funds, are perceived as having a greater [[risk|appetite for risk]], with the intention of maximizing returns,<ref name="What is a Hedge Fund">{{cite web |url=http://www.barclayhedge.com/research/educational-articles/hedge-fund-strategy-definition/what-is-a-hedge-fund.html |title=What is a Hedge Fund |publisher=BarclayHedge Ltd. |access-date=28 March 2011 |archive-url=https://web.archive.org/web/20110316110730/http://www.barclayhedge.com/research/educational-articles/hedge-fund-strategy-definition/what-is-a-hedge-fund.html |archive-date=16 March 2011 |url-status=live |df=dmy-all }}</ref> subject to the [[risk tolerance]] of investors and the fund manager. Managers will have an additional incentive to increase risk oversight when their own capital is invested in the fund.<ref name=Cassar/>