Interview with Lars Jaeger, author of Risk Management for Alternative Investment Strategies
PE: Where did the idea for the book come from?
LJ: In recent years hedge funds have received wide attention in the investment community. With this increasing popularity, the literature about this topic has grown considerably, and the interested reader now has a choice among many different views and approaches. However, despite the huge importance of risk management in the hedge fund investment process, many investors lack an in-depth understanding of the various types and degrees of risk that Alternative Investment Strategies (hedge funds and managed futures) are exposed to, and also lack an understanding of the tools available for measuring and managing risk. Effective risk management entails both a qualitative understanding of the AIS risk factors, as well as a quantitative means of measuring and describing risk.
I have been working for a number of years in the area of AIS risk management. As part of a fund of funds operation investing with many different hedge fund managers, I have experienced first hand the importance of knowing about risks and risk management in this industry. I am surprised that the industry still lacks comprehensive coverage of the important topic of AIS risk management, and wanted to provide the industry with an in-depth discussion of this important topic.
I did not write this book to give another introduction into hedge funds (as there are plenty), but to specifically educate the reader about how the rewards of AIS investing can be obtained without being exposed to unacceptable levels of risk.
PE: If we read your book, what will we get better at?
LJ: The challenges of AIS risk management are twofold: complexity and rapid change. AIS are much more complex and varied than traditional asset classes, and AIS risk management requires a thorough understanding of many different underlying strategies. Yet these strategies are changing even as investment professionals and risk managers struggle to understand them. To make matters worse, the overall risk management practices of the investment community are also rapidly changing across all asset classes. The "state of the art" in financial risk management has developed dramatically over the past few years, with new paradigms and ever more complex models continuing to emerge.
While confusing to some investors, these new tools create new opportunities to monitor and "fine tune" risks in AIS investments much more accurately than just a few years ago. Active risk management can add tremendous value to the investment and asset allocation process of AIS investors and managers. I believe that this book will provide readers and investors with the knowledge needed to reap these rewards. The book will:
- discuss in detail the various risks by strategy sector;
- introduce principles of modern financial risk managements applicable to AIS;
- present a risk management process for alternative investment strategies (ie hedge funds and managed futures) that is fully integrated into the investment process.
PE: Is this one for a global audience?
LJ: Yes, as much as the hedge fund (as well as the financial risk management industry) is a global industry. An interest in hedge funds is spread across investment professionals with very different backgrounds – so this book aims to provide a wide range of financial professionals, including hedge fund and managed futures managers, fund of funds managers (AIS allocators), brokers, administrators, custodians, and private and institutional investors, with an understanding of AIS risks and risk management. But the book is also well suited for other types of professionals involved with addressing the challenges of AIS risk, such as regulatory agencies, consultants, legal authorities, financial journalists, and students. Despite the broader view taken on the subject, I hope even AIS experts will benefit from the risk management discussion presented.
PE: What's going on in the business world today that your book has something important to say about?
LJ: In order for hedge funds to achieve full recognition as a separate asset class and develop their full potential in the financial community, the industry must address both growing investor concerns about their diverse risks, and the lack of investment transparency, low liquidity, and long redemption periods which are generally characteristic of hedge fund investments.
The trend in investors’ attitude from accepting ("trust me") to requesting ("show me") is clearly observable. While for years investors accepted a black box approach to AIS investing, a number of factors are leading to a shift away from this type of approach:
- increased interest from institutional investors in AIS has led to new demands for disclosure, due to the fiduciary responsibilities associated with investing clients’ money;
- several widely publicised hedge fund failures during the market crisis of 1998 (such as LTCM) and periodic reports of other hedge fund "blow ups" and fraud (such as the "Manhattan Hedge Fund" in the spring of 2000), have added to the concerns of all AIS investors about the risks of their AIS investments; and
- rapid developments in the financial industry in the area of financial risk management have made risk analysis for even complex AIS portfolios feasible on a real-time basis, and therefore have increased expectations with respect to the management of risk.
As a result of these recent developments, the AIS industry is currently going through an institutionalisation process, where Hedge fund managers are increasingly faced with demands for increased investment transparency, higher liquidity (i.e. shorter redemptions periods) and greater clarity in terms of portfolio composition, strategy details, performance and fee attributions, and leverage.
The book discusses a new "transparency paradigm" for hedge fund investing and describes the AIS investment process within the framework of transparency and risk management.
PE: If there is one critical message that you would like readers take from your work, what would it be?
LJ: There is nothing mysterious about hedge fund investment strategies – they can be readily understood by the sophisticated investor. The incorrect belief that the best performing managers must operate in secret (black box) is linked to persistent misperceptions about hedge funds. Many investors believe that AIS returns are mostly generated through the identification of unrecognised "inefficiencies". The reality of AIS investing is that many hedge fund strategies systematically earn premiums in return for assuming certain risks. Most managers follow systematic investment strategies that, not surprisingly, perform better in certain market environments than in others, and which bear a range of risks. These risks have to be understood and managed. Good risk management is a key performance driver for hedge funds.
PE: How does your book differ from/build on the work of previous books on this topic?
LJ: There are a few books published where different authors describe their views about this topic in individual articles. Some of these articles are excellent, while others are quite poor. My book is specifically aimed at providing the reader with a full and coherent coverage of risk in AIS. It also provides numerous references to the current literature. The books aims at becoming a first reference book for the topic of risk management for Alternative Investment Strategies.
PE: If we want to explore or implement these ideas further, what should we do?
LJ: The book provides the reader with a detailed description of an integrated investment and risk management process for hedge fund investment. The process and key points for the implementation are described in detail in Chapter VII of the book. Further, as mentioned above, the book provides extensive references to available literature for readers who want to explore particular ideas or concepts in greater detail.
PE: Are there any businesses out there today that you think are really getting this right? Or wrong?
LJ: Investors’ views range from managing risk through diversification across many managers (including black box strategies) such that a limited number of manager "blow ups" (e.g. LTCM, Manhattan fund) have a minimal effect on the portfolio, to a fully transparent and actively risk controlled investment approach. I advocate the second approach, but a black box investment approach to hedge funds is still quite widespread. My company, Partners Group of Switzerland, is a leading fund of hedge fund operation that focuses especially on transparency, liquidity, and sophisticated risk management for alternative investment strategies.