Hedge Funds

CMRA has consulted to many hedge funds on issues ranging from best practice to risk branding to VAR to valuation. CMRA is an active member of the Alternative Investment Management Association (AIMA) and Leslie was on the Board of 100 Women in Hedge Funds for its first three years and chaired its Philanthropy Committee.

Ms. Rahl is the author of Hedge Fund Transparency: Unravelling the Complex and Controversial Debate, published in March 2003 by Risk Books, and the editor of Risk Budgeting: A New Approach to Investing, published in November 2000 by Risk Books. Her articles have appeared in a wide range of publications.

Selected Assignments - Hedge Funds

• Conducted due diligence on hedge fund's for numerous funds of funds and institutional investors
• Vetted many complex pricing models for complex Derivatives, CDO's, CLO's etc.
• Helped several hedge funds "risk brand" themselves
• Represented a large hedge fund in litigation re: margin calls on TRS
• Advised on the unwind of an emerging market fund and valued over 100 derivative positions including total return swaps (TRS) and credit default swaps (CDS)
• Drafted and reviewed risk management policies and practices for numerous several hedge funds
• Advised major global macro fund regarding "Risk Branding"
• Advised pension fund in asset allocation for alternative investments
• Advised several clients on Chief Risk Officer (CRO) roles, responsibilities and selection
• Conducted a multi-client study on buy-side risk management
• Co-chaired the IAFE's Investor Risk Committees Best Practices group
• Analyzed the valuations in a litigation relating to margin calls on an MBS hedge fund
• Valued emerging market credit derivatives for a major hedge fund
• Benchmarked hedge fund transparency practices and needs of hedge funds, funds of funds and investors
• Conducted several widely published surveys on hedge fund risk management
• Provided a monthly "fair value" opinion for a technology hedge fund
• Commissioned by the prestigious Alternative Investment Management Association (AIMA) to prepare a research report on fund of funds vs. individual hedge fund investing
• Vetted many complex pricing models
• Provided valuation and market practice expert report and testimony in litigation related to Askin/Granite funds meltdown
• Designed and helped implement a VAR process for a leading hedge fund

Publications - Hedge Funds

• The biggest "CIO" Risk - Alpha" Risk Manager" (complex, illiquid, opaque) - AIMA Journal – Feb. 2008
• Risk Management An Evolution Forum "Gut to Quant to Wisdom" - AIMA Journal – Sept. 2005
• A New Approach to Risk-Adjusted Asset Allocation for Hedge Fund Investing - AIMA Journal – Sept. 2003
• Managing the Risks of Alternative Investment Strategies Chapter 8 - Due Diligence - Euromoney Books – Fall 2003
• Hedge Funds: A Definitive Overview of Strategies and Techniques Chapter 9 - Risk Management - John Wiley & Sons – August 2003
• Beyond the Basics - Due Diligence - 2003 HedgeWorld Compendium – July 2003
• Hedge Fund Transparency-Unravelling the Complex and Controversial Debate - Risk Books – March 2003
• Risk Management for Hedge Funds and Fund of Funds – ICMA – Jan. 2003
• Safety First - ICFA/AIMA Investment Supplement – Dec. 2002
• A Guide to Fund of Hedge Funds Management and Investment – AIMA – Oct. 2002
• Institutionalization of Hedge Funds - Institutional Investor – Fall 2002
• Different Perspectives of Hedge Fund Transparency - Alternative Fund Services Review – Oct. 2002
• Hedge Fund Risk Transparency - AIMA Newsletter – Feb. 2002
• Survival After The Blaze - AIMA Newsletter – April 2001
• Risk Budgeting, A New Approach to Investing Edited by Leslie Rahl - Risk Books - 2000

Recent and Upcoming Speeches re: Hedge Funds

November 2010

October 2010

Selected CMRA in the Press re: Hedge Funds

Opinions Diverge on Who Calls Valuation Shots When Liquidity is Scarce
Martin de Sa'Pinto, Senior Financial Correspondent

MONTE CARLO, Monaco - The liquidity crunch brought home to many investors, portfolio managers, service providers and prime brokers how sharply valuations can diverge when a portfolio becomes unexpectedly illiquid. This was particularly true for highly leveraged portfolios that, as the result of not-always-sharp fluctuations in the prices of securities, found themselves facing margin calls and forced to unwind positions rapidly.

The complexity of the security in question is clearly an issue, and when there is a lack of consensus on valuation methods, different constituencies will often make a strong case for completely distinct methods that can produce widely diverging valuations.

This was the basis for a panel discussion at the Global Alternative Investment Management conference in Monaco on June 19 was moderated by Henny Sender, international financial correspondent at the Financial Times.

"Valuation and transparency are among the hottest topics facing hedge funds and investors today," said Ms. Sender in her introduction. "How quickly can valuations change? If you don't have a good sense of valuation you cannot manage the risk of your positions."

In such circumstances, "I was a diehard advocate for mark-to-market, and I still believe it's the lesser of evils, but there are times when model-based pricing might make sense," said Ms. Rahl. This would of course imply that the model-based methodology was favored over mark-to-market because either market prices were stale or unavailable, or the relationship between the underlying and the proxy was weak. "The option of using such a valuation methodology would require strict checks and balances within a fund," she said.

"Marks on the collateral don't necessarily represent the price at which a trade can be unwound," said Ms. Rahl. "In some situations we have seen the exact same trades with two different counterparties being unwound at vastly different prices."

Ms. Rahl said relevant documentation, including research reports, broker quotes and screen shots, should be printed out and kept on file so that it is at least available in the case of a dispute.
(July 2008)

VaR Enough?
Market turbulence tests the limits of Value at Risk
By Irwin Speizer

When an investment bank that is supposed to know better loses billions of dollars betting on subprime mortgages, you have to wonder what happened to the concept of risk management. "You can't rely on VaR as your only metric," says Leslie Rahl, president and founder of New York–based Capital Market Risk Advisors. "We recommend people use three to five different metrics. It's like a doctor ordering an X ray, an MRI and a CAT scan — they all tell you slightly different things."

A veteran of 35 years in the financial industry and a financial engineering pioneer, Rahl ran the derivatives business at Citibank in the 1980s before establishing her consulting firm in 1991. She preaches the importance of rigorous risk analysis and testing to cope with the impact of the types of investments she peddled in her earlier role.

Rahl recommends applying stress tests to see how a portfolio would react to sharp drops, market shifts, unusual situations or changes in underlying assumptions. Stress-testing models, which are included in risk systems, can reveal weaknesses that a simple VaR test misses. But Rahl says too many financial firms continue to rely mostly on VaR. Back in April 2000, Rahl's firm conducted a survey of risk practices and found that 45 percent of financial firms, including hedge funds, were not using stress tests at all. Although she hasn't updated the survey, she says she has noticed only a slight improvement since then.

"In risk management only about a third is quantitative," Rahl says. "A third is still a big part of the puzzle, so it is quite valuable." The remaining two thirds of the puzzle is where good risk managers earn their money. Ultimately, an accurate forecast depends on knowledge, experience and chutzpah.

"It has nothing to do with the computer," Rahl says. "It has to do with wisdom and experience."

And perhaps a bit of luck.
(June 2008)

 
Debtwire
Citibank responds, sues for breach of contract in credit default swap case
By Danielle Reed, New York

Citibank filed a response 23 April and countersued for breach of contract in its ongoing court battle with a hedge fund over a credit default swap.

Whatever the outcome of this particular case, the mere fact that such issues are being litigated highlights a source of concern to longtime derivatives market participants: Namely, the growing participation of hedge funds in the CDS market. "One of the things that has been of great concern to me for a long time is [the] many new entrants to the credit default swap market, especially hedge funds who have not cut their teeth on less complex over-the-counter derivatives...before taking on large sized positions in CDS," said Leslie Rahl, founder and president of Capital Market Risk Advisors. A pioneer in the derivatives market, Rahl said she is "pro-derivatives" but fears that "some of the newer players don't fully understand the differences between a liquid, transparent securities market and the world of over-the-counter derivatives."
(April 28, 2008)

Don't Trust the Wall St rally
By Bethany McLean, Editor at Large

Up till now, all eyes have been on the losses that are hitting the financial sector from the acronym soup of new instruments such as CDOs and SIVs. Everyone is scared, and rightly so of the MUB (Monster Under the Bed) that might be lurking in supposedly safe havens.

The last decade saw the explosion of securitization – the carving up and redistributing of risk-the boom in hedge funds, and the private equity mania.

In a paper published in the fall of 2005, risk management gurus Leslie Rahl and Barbara Lucas of Capital Market Risk Advisors, noted that in the past decade, a lot of things have happened that aren't supposed to happen, from the interest rate hikes of 1994 to the 1998 collapse of LTCM to the 2001 terrorist attacks. Or as the authors put it, "once-in-a-lifetime events seem to occur every few years."
(March 23, 2008)

The Blow-Up
This summer, as a meltdown in the subprime credit market spilled over into other markets, all eyes were on the mathematically trained financial engineers known as "quants." Who are these guys?
By Bryant Urstadt

On Wednesday, August 8, not long after the markets closed, 200 of the smartest people on Wall Street gathered in a conference room at Four World Financial Center, the 34-story headquarters of Merrill Lynch. They were "quants", and they had a lot to talk about, for their work was at the heart of one of the most worrisome summer markets in decades.

The conference sponsored by the International Association of Financial Engineers (IAFE), and its title asked, "is Subprime the Canary in the Mine? "Subprime" borrowers are home buyers whose poor credit history means they don't qualify for market interest rates.

The panel was moderated by Leslie Rahl an MIT graduate and the founder of Capital Market Risk Advisors. Her job is to advise companies on risk and help them understand the products quants invent. But understanding was in short supply in August. Some of the quants' financial products had collapsed in price, with unexpected consequences in another financial sector: the trading of equities.

And was subprime the canary in the mine? Leslie Rahl, for instance, cautiously told me in a follow-up e-mail that it is "looking more and more like the answer is yes." Many signs have suggested so, from job losses to a continuing credit drought to a weakening dollar, but that history has not yet been written.

As a prelude to the panel discussion, Rahl, asked the audience to predict whether credit spreads would shrink or widen in the coming months. She was talking about the difference between the price of a treasury bond and the price of a riskier corporate bond, a standard Wall Street gauge for the health of the economy. A widening credit spread is generally seen as a sign of uncertainty, and a narrow spread as a sign of optimism.

"How many think spreads will widen?" she asked. The hands of about half of the smartest people on Wall Street shot up. "And how many think they'll narrow?" The other half—equally smart—raised their hands. "Well," she said. "That's what makes a market." If they didn't know, nobody could.
(November/December 2007)

Subprime and Hedge Funds: Hard Lessons to Learn Here?
Emma Trincal, Senior Financial Correspondent

The subprime crisis has sent a jolt this summer through the global financial markets and across stocks, bond markets and even money market funds. But what exactly is the role played by hedge funds in this global shakeout? And what can the marketplace learn from it?

"If CDO and structured products are affected by further downgrades, many of such investors will be forced to sell the paper. This will cause a float of paper that will depress this market," says CMRA's Ms. Rahl. And as a result, hedge funds holding CDOs or MBS will be hit with further losses.

But managing liquidity risk won't be easy.

"We can't really measure liquidity," says Ms. Rahl. "Liquidity can change over time. Something can be very liquid today; then something happens and it becomes illiquid." In an illiquid market, managers will have to decide how much yield they need on any given instrument to compensate for the lack of liquidity. A firm with a lot of cash reserves can afford a margin of error in those risk assessments. A smaller fund with less liquidity can't.

Another way to control liquidity for a hedge fund is to impose longer lock-ups on investors. Opinions vary on this measure. "I don't know if hedge funds will resist the temptation to impose lock-ups, yet they should," says Mr. Easterling. "Longer lock-ups would only apply to new investors and would not impact existing investors. The only way to reduce the liquidity risk of existing investors is to lock-down the fund … and that is a death knell for a fund," he says.

"The trend of longer lock-ups already exists, but it will continue," says Ms. Rahl. "But you won't see extended lock-ups all across the board. There will be maturity ladders." Such a formula allows a manager to offer a fee schedule based on the length of the lock-up with the fees decreasing when investors agree to stay longer.

"People are focused on leverage, but what we're really seeing is embedded leverage," says Leslie Rahl, founder and president of Capital Market Risk Advisors Inc., a New York-based financial advisory firm specializing in risk management. "Some hedge funds have indirect leverage because they are holding structured products that are less liquid and which they can't sell. It's not clear whether leverage ratios are going to decrease as a result of this crisis. Actually, leverage levels are much lower than they were during the 1998 crisis."

Whether the critics are unfair or not, one sure way to protect a portfolio was to be skeptical about everything, including the ratings.
(September 13, 2007)

Market volatility puts risk at forefront
By Jay Cooper

"In general, liquidity doesn't enter into the metrics used by pension funds," said Leslie Rahl, president of Capital Market Risk Advisors, a New York-based financial advisory firm specializing in risk management.

"In times like these, non-quantitative measures need to supplement normal risk reporting. The best defense is asset allocation, manager selection and effective risk due diligence," she added.

As part of their due diligence process, pension fund officials should also be asking managers how they value instruments like CDOs that do not trade on a liquid market, Ms. Rahl said. She said pension executives should be wary of managers who allow the trader to value those securities themselves.
(August 20, 2007)

The Pain Moves Beyond Subprime
By Matthew Goldstein and David Henry

The ultimate worry is that the trouble in the junk-debt markets will spread to the traditional corporate bond market and create a full-fledged credit crunch that would threaten the economy. That scenario may be unfolding. Issuance of investment-grade corporate bonds fell 72% in July from June's level and 34% from July, 2006, according to Dealogic. And some say the subprime-mortgage and leveraged-loan markets are harbingers of wider credit troubles. …Adds Leslie Rahl, president of Capital Market Risk Advisors in New York and former co-head of Citibank's derivatives group: "Nothing stays rosy forever. We've been in a rosy world, with credit spreads at historically tight levels for some time now. But we seem to be leaving it."
(August 2, 2007)

Levered Bear Funds: A Peek into the Black Box
By Chidem Kurdas

"People forget that even when there's careful mark-to-market pricing, portfolio valuation does not necessarily reflect the actual price you'll get at execution," said Leslie Rahl, president of Capital Market Risk Advisors in New York. "There can be a huge difference between honest mark-to-market price and execution price."
(June 26, 2007)

The calm after the storm - or the eye of the hurricane?
By Suzanne McGee

Late February's stock market rout sent the Dow Jones Industrial Average to its largest one-day loss in more than four years, and sent prices on the riskiest kinds of debt into a nosedive.

Then something odd happened: The sky didn't fall.

But an important four-letter word - risk - has crept quietly back into the marketplace once more. Risk-aversion may not be dominating headlines today the same way it did three or four weeks ago, but it is lurking in the background, waiting for another opportunity to surface.

"We can't rewind the clock and go back to the environment where people felt as carefree as they seemed to in the first month or two of 2007," says Leslie Rahl, a founder of Capital Market Risk Advisors, a firm that has advised financial institutions on managing all kinds of risks since the mid-1990s, when the first derivative debacles roiled financial markets.

Rahl isn't fielding calls from clients desperate to extricate themselves from the fallout of a risk misjudgment. Still, she sees the turmoil of late February and early March as the first stage in a global repricing of risk that is long overdue, and she is urging those clients to "stress test" their portfolios in anticipation of more upheaval.

"While I don't sense that the market believes today that this is imminent, there is general agreement that it has to happen; in some markets, risk premia are as tight as they have ever been," Rahl says. "I think the future is more fragile than the market is pricing it today, and the biggest lesson of the subprime market's implosion so far is how quickly risk can be repriced."
(April 9, 2007)

Hidden risk: Investors skim over question of fund valuation
By Christine Williamson

"With so much money rushing into hedge funds, people are very anxious about preserving capacity and that's when they begin to cut corners, when it becomes more of a seller's market. But it's the fiduciary responsibility of (institutional) investors to make sure that their fund-of-funds managers are asking all of the right questions about the process of due diligence and portfolio construction, including valuation. It's a bad assumption to think that all fund-of-funds companies are conducting the right level of analysis on the hedge funds they use," said Leslie Rahl, president and chief executive officer of Capital Market Risk Advisors LLC, New York, a hedge fund risk analysis firm and consultant.

"There is enormous interest in this area, but there is still a lot of education to be done of both investors and managers," said CMRA's Ms. Rahl. ``There are a lot of nuances that people are not fully comprehending. Questions have to be very carefully tailored for each kind of strategy. Valuation is an issue any time you have an instrument that's not traded in a transparent, liquid market. Intelligent, well-meaning people will often price the same securities very differently."

The Investor Risk Committee of the International Association of Financial Engineers, Washington, for example, released a white paper on hedge fund portfolio valuation recommendations in early June. Ms. Rahl has served on the IAFE committee that worked on the recommendations for the past two years and co-chaired it last year.
(July 12, 2004)

AIMA Releases Fund of Funds Guidebook
By Susan L. Barreto

The Alternative Investment Management Association Ltd. has released the results of the research on hedge fund of funds it commissioned in 2001, complete with commentary from practitioners.

A 96-page book, "A Guide to Fund of Hedge Funds Management and Investment," covers a broad range of topics including risk management, transparency, hedge fund selection and benchmarking, liquidity, fees and due diligence.

Capital Market Risk Advisors, New York conducted the research, parts of which have been released throughout the year. CMRA coordinated and co-edited the guide that includes three comprehensive surveys of institutional investors, hedge funds and hedge funds of funds completed in the last year.
(October 21, 2002)

Preliminary findings from a study of funds of funds by Capital Market Risk Advisors (CMRA) in conjunction with the Alternative Investment Management Association show that institutional investors are still nervous about the lack of transparency and the high risk involved in investing. The study's early findings also show that fund managers and fund of fund managers are hesitant to embrace the idea of best practices or reporting standards. The CMRA study is scheduled for completion and release in August of 2002.

"There is a tug of war going on," said Leslie Rahl, president of CMRA, who shared these preliminary results during a panel on transparency and disclosure at the 9th Annual Hedge Fund Forum held in New York this week. Managers in the alternative investing world are typically anti-bureaucracy and anti-authority, she added. And investors are inclined to demand adherence by managers to "best practices," a full understanding of risk in each fund, and funds with stable infrastructure and investment processes that are not reliant on a single manager.
(June 6, 2002)