| The first of a two part article | | | | If you own a mutual fund, chances are your fund is |
| Fund managers, whether they be equity or bond | | | | un-hedged. Until recently, mutual fund legislation |
| traders, know all too well that returns are not simply | | | | prevented mutual funds from hedging. Many |
| a result of their asset selection prowess. Many | | | | jurisdictions have repealed this rule however mutual |
| external factors come into play. But what are the | | | | fund managers have been slow or decided to |
| issues facing the professional money manager. Not all | | | | continue with "business as usual". The reason is that |
| fund managers analyze their market risk. This is often | | | | most investors of mutual funds are unsophisticated |
| explained as a lack of education and a failure to | | | | and do not understand the hedging process and may |
| understand the mitigating solutions for off-setting risk. | | | | re-deem their money from an investment strategy |
| Market risk is defined as "the unexpected financial | | | | they do not understand. |
| loss following a market decline due to events out of | | | | Hedge funds on the other hand do not have these |
| your control." Stock or bond market volatility or | | | | restraints. Investors are more sophisticated and are |
| market reversals can be the result of global events | | | | more open to the nature of hedge fund strategies. |
| happening in far flung corners of the globe. Top | | | | Some of which are not disclosed due to a fear of |
| analysts and fund managers simply do not have the | | | | piracy by competing hedge fund managers. |
| resources to crystal ball gaze and predict those | | | | Risk reduction solutions are not complicated but do |
| events. | | | | require the services of a professional who |
| Examples of several major unexpected events that | | | | understands the process. This is the role of a |
| sent shock waves throughout the financial | | | | Commodity Trading Advisor, also known as a CTA. |
| community have been: | | | | While most CTA's are hedge fund managers, few |
| - 1982 Mexican Peso devaluation; | | | | specialize in risk management analytics. The focus of |
| - 1987 stock market crash knows as "Black Monday"; | | | | a risk manager is on the analysis of solutions to |
| - 1989 USA Savings and Loan Crisis; | | | | reduce or eliminate market and / or operational risk. |
| - 1998 Russian Ruble devaluation; | | | | No matter the role, all Commodity Trading Advisors |
| - 1998 $125 billion collapse of Hedge Fund Long Term | | | | are specialists in the derivatives market. |
| Capital Management; | | | | The first step is the value at risk calculation to |
| - 2006 collapse of Hedge Fund Amaranth with losses | | | | determine a funds risk liability. A risk mitigation |
| of $5.85 billion. | | | | strategy known as a hedge is then implemented. |
| In 1994 Bank J.P. Morgan developed a risk metrics | | | | After all, identification of one's risk is only beneficial if |
| model known as Value-At-Risk or VaR. While VaR is | | | | a solution to off-set that risk is put into place. |
| considered the industry standard of risk | | | | Hedging requires the use of derivatives, either |
| measurement, it has its drawbacks. VaR can measure | | | | exchange traded or over-the-counter. These can |
| total dollar value of a funds risk exposure within a | | | | take many forms. The most commonly used hedging |
| certain level of confidence, usually 95 or 99 percent. | | | | instruments are index futures, interest rate futures, |
| What it cannot do, is predict when a triggering event | | | | foreign exchange, exchange traded commodities such |
| will occur or the magnitude of the subsequent fallout. | | | | as Crude Oil, options and SWAPS. |
| For some company's and funds, a steep decline or | | | | A more detailed explanation of derivatives and |
| protracted recession can be devastating. Even forcing | | | | hedging will be discussed in our next article. Now that |
| some un-hedged firms into bankruptcy. A triggering | | | | we've identified an easy solution for your market risk |
| event can have a ripple effect forcing people out of | | | | worries, the implementation of the right strategy can |
| work and economies into recession effectively | | | | be as easy as a call to a qualified and registered |
| putting more people out of work. No person and no | | | | Commodity Trading Advisor. |
| economy is immune. | | | | |