Risk Management

The necessity for Hedge Fund risk modelling and management originates from 2 areas.

• Firstly, Hedge Funds have been responsible for numerous large losses, causing them to completely collapse and initiate a contagion effect by affecting numerous economic and financial sectors. The most notorious example of such a loss being the Long Term Capital Management Hedge Fund, which lost US$2.1 billion and almost brought down the entire US financial system.
• Secondly, as already mentioned, mutual funds are tightly regulated whereas hedge funds face little regulation. However, as hedge funds have gained public attention and therefore more investment interest, this along with spectacular hedge fund disasters have prompted increased hedge fund regulation.

It was not until after the 1997 Asian Currency Crisis though that regulator became interested in monitoring hedge fund actions. The International Monetary Fund initiated a study on the market influence of hedge funds which described hedge funds activities and the potential problem of the market impact of Hedge Funds. Moreover in 2004, the Securities and Exchange Commission now required Hedge Fund managers and sponsors to register as investment advisors under the Investment Advisor’s Act of 1940. This greatly increases the number of requirements placed on hedge funds e.g. keeping records and creating a code of ethics.