Friday, October 27, 2006

Risk


San Diego parts company with their consultants, providing another lesson from Amaranth.
Sophisticated due diligence may not fully identify the risks implicit in many hedge fund strategies and new investment products. Hedge fund returns are not normally distributed. They can exhibit extreme levels of skewness and kurtosis. Because of this, standard measures of volatility are insufficient to measure hedge fund risk. Mean variance analysis, which is commonly used to develop portfolio asset allocation strategies, isnt an adequate tool for these strategies.

If your pension plan has hedge fund exposure and the rationale for that investment shows up on a standard "efficient frontier", you don't have all the information you need to evaluate its risks.

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