CMRA in the Press 2003

In May, Capital Market Risk Advisors Inc., New York, brought Barbara Lucas on as a partner at the company, which constructs funds of funds and offers other hedge fund-related services. In addition to Ms. Lucas's corporate banking and investment management law experience, she served as chief counsel to the CFTC's Division of Enforcement, was director of the CFTC's Office of Policy Review and served as special counsel to the SEC's Division of Corporation Finance, where she was in charge of the Corporate Governance Task Force and other regulatory initiatives.
(December 12, 2003)

Absolute return strategies: Pennsylvania doubles hedge fund allocation;
Fund-of-funds investments part of overall target allocation changes

Trustees of the $22.7 billion Pennsylvania State Employees' Employees' Retirement System, Harrisburg, last week approved new asset allocation targets, including a 20% exposure to absolute return strategies. The old target had been 10%.

"A 20% allocation to hedge funds is high for a public plan, but remember that some endowments and foundations are up in the 50% range," said Leslie Rahl, president of Capital Market Risk Advisors LLC, New York, a hedge fund consultant. "It's a very important statement about the speed with which public plan sponsors are learning and are growing into the hedge fund arena."
(December 8, 2003)

Advantage of closed funds questioned

Contrary to prevailing belief, hedge funds that are closed to new investment do not perform significantly better than ones that are open, according to a study by Capital Market Risk Advisors, a research group.

CMRA studied the performance of 3,700 hedge funds and found that the open funds outperformed closed ones by 0.1 per cent overall. However, the differential was affected by the strategy followed. Funds specializing in managed futures, emerging markets, convertible arbitrage and global macro strategies all performed better when closed - by a margin of up to 4.9 per cent.

Event-driven, fixed-income, long/short and merger arbitrage funds all did better if they were open. The biggest difference was in merger arbitrage funds, where the open funds showed a return since inception of 22.8 per cent but the closed funds reported a return of only 8.5 per cent.

Many investors and industry members have believed that closed hedge funds perform slightly better because they have a concrete amount of capital to use free from the distractions of marketing and putting big inflows of new money to work.
(October 06, 2003)

CAPITAL MARKET RISK ADVISORS, INC.

CMRA has announced that Barbara Lucas has become a partner in the firm. Ms. Lucas, a well-known securities and banking lawyer with more than 25 years of experience in law, business and government and formerly a partner in Cadwalader, Wickersham & Taft, will offer consulting, compliance, educational, and other services to corporate boards and managers, plan sponsor trustees, mutual fund boards, hedge fund managers, counsel and compliance personnel with respect to a broad range of corporate governance, 'best practices', legal and reputational issues.
(September 2003)

Wall St. takes stock five years after LTCM crisis.

NEW YORK - Five years after the huge hedge fund Long-Term Capital Management (LTCM) crumbled and shook the global financial system, banks and regulators have learned hard lessons about leverage and risk.

Risk managers say much has changed because of the 1998 crisis that led the U.S. central bank, the Federal Reserve, to make an emergency interest rate cut to restore market confidence and help organize a last-minute, Wall Street bailout.

Since then, banks have fortified risk controls in their dealings with hedge funds, which borrow heavily to boost their market bets. That leverage magnified LTCM's early successes but also led to its meteoric fall from grace.

Bank supervisors have become savvy about staying on top of the latest trends derivatives, which are often the heart of such financial crises because they can be used to build up leverage.

But some of the same dangers that led to LTCM's systemic threat still remain. For one thing, heated competition means investment banks are eager to lure the lucrative business of hedge funds, tempting executives to look the other way as they pursue profits.

Analysts at credit ratings agencies Standard & Poor's question the robustness of bank risk models that are typically based on assumptions about market conditions that can quickly go awry. The failure of LTCM's models has underscored why they're viewed skeptically.

And while hedge funds have given banks more information on their trading activities, some analysts question whether that data accurately portrays the whole story. For example, LTCM's models grossly understated its potential losses despite having a derivatives portfolio with a nominal value of nearly $1.5 trillion.

"LTCM increased the amount of transparency from hedge funds, but it's not very well defined," said Leslie Rahl, a partner at Capital Market Risk Advisors, a New York-based risk management advisory firm.

"The whole issue of valuation is a big one," she said, particularly for instruments ranging from mortgage-backed securities to many derivatives for which trading is not always active and price quotes can vary greatly.
(September 26, 2003)

Alumni Club of Boston Presents the First Annual MIT Sloan - Women in Business & Technology Symposium

The first annual "Women in Business - Breaking New Ground," women's symposium will be held at the MIT Sloan School of Management on September 20, 2003.

Featured speakers will include Ellen Roy Herzfelder, Secretary for the Massachusetts Executive Office of Environmental Affairs; Leslie Rahl, President of Capital Market Risk Advisors and Partner at L2 Alternative Asset Management; and Alison Ross, Founder of Smart Finance. Nancy Guida, Vice President of Marketing & Strategic Planning for Catalyst, will kick off the day with the latest findings from the leading non-profit research and advisory organization working to advance women in business. Tania Zouikin, Chairman of Batterymarch, will provide the capstone summarizing the insights from the day.

In the last century, women have attained unparalleled levels of education and professional success. This symposium is the first in a series that will explore: the many routes that women take to successfully pursue their business goals and personal objectives, the success stories and strategies that have worked, and the obstacles we continue to face along the way. The all-day symposium is organized around panel discussions focused on four main topics: work/life balance, surviving corporate politics, exploring career transitions, and effective networking.
(September 19, 2003)

Measurisk, about to close its doors, needs to find cash infusion or buyer

Measurisk LLC, a provider of Internet-based risk dat and analysis for institutional investors, is on the verge of going out of business.

The company, which started five years ago during the dot com boom, is almost broke. Executives are desperately searching for someone to either inject new money into the company or but it outright.

"It's a shame in many ways because they had an interesting product," said Leslie Rahl, president of Capital Market Risk Advisors, New York, which provides risk analysis for institutional investors.
(September 15, 2003)

100 Women Announce Second Annual Gala Event

The members of 100 Women in Hedge Funds are planning their second annual gala for Nov. 18, honoring hedge fund legend George Soros and Elaine Crocker, president of Moore Capital Management, Inc., a prominent hedge fund firm.

Organizers will present Mr. Soros with its "100 Women in Hedge Funds Effecting Change Award" for his contribution to education. Ms. Crocker will receive the "100 Women in Hedge Funds' Industry Leadership Award," for her work as a pioneer in the hedge fund industry.

Meanwhile the proceeds for the dinner, which will be held at New York's Cipriani 42nd Street again, will go to two educational charities: Right Start/Infant Academy and The After School Corporation.

TASC and New York City Department of Education After School Programs will get funding to expand their work with middle school students. Of particular appeal to hedge funds is that TASC will lever every dollar raised three to one, to maximize the groups impact.

"This is more than just a financial commitment to these charities," Leslie Rahl, chair of the Philanthropy committee, said in a statement. "Our goal is to help design, document and test these programs and then roll these important programs out nationwide."

100 Women has quickly grown to 1,900 members, who are women professionals in the hedge fund and related industries. The groups first gala, last December, raised almost US$1 million for breast cancer research.
(August 21, 2003)

The Business of Hedge Funds: The Manager's Perspective
Risk Transparency: How much do you want?

The word "risky" gets used a lot after a hedge fund fails. When Long-Term Capital Management collapsed in 1998, reporters became entrenched in a habit of describing hedge funds as risky. In the past year or so, several high-profile failures sparked debates as to whether there managers had taken excessive risk. "Risk management queried," ran a headline about Beacon Hill, the mortgage-backed securities firm that suffered heavy losses in 2002.

Its ubiquity has not made the concept of risk easier to grasp, partly because it has so many facets an partly because the idea is not very useful on its own. Risk needs to be taken in relation to other considerations such as expected return. "I don't know how to make money without taking risk," points out Leslie Rahl, president of Capital Market Risk Advisors, New York. "As long as you have an understanding of the risk and a realistic measure for it, I don't see a problem. You don't get rid of risk because then you wouldn't make money."

Risk and Reward
The first question is where an investor wants to be on the risk and return tradeoff. Do you want to take a potential return of 20% at a higher risk or 8% at lower risk? "Neither one is better than the other-they are different and investors should have a clear understanding of the tradeoff," said Ms. Rahl. "They should not think they're getting the same risk with the 20% investment as with the 8%."
(August 2003)

Third-parties fill the gap - RISK MANAGEMENT

The world is an increasingly risky place and risk management is no longer just the preserve of hedge funds. But the wider awareness of risk has highlighted the difficulties non-specialists face in using risk management tools and techniques.

There is thus growing interest in using third party providers to manage and hopefully, minimize risk.

The finance sector knows all about risk, of course. Past trading scandals have led to tighter accounting and disclosure rules, and the forthcoming Basel II Accord represents the latest attempt to improve the soundness of the financial system.

"There has been a massive push for regulation after some very spectacular demises," says Mike Whitaker, managing director for trade and risk management at Reuters, the financial information company.

Basel II has put the spotlight on risk management as it aligns a bank's capital adequacy assessments more closely with the underlying risks.

"If you can show that you run a more resilient bank, you will be awarded with smaller capital reserve requirements," says Mark Greene, general manager of IBM's global banking division.

A survey commissioned by IBM found that only half of financial institutions can measure their operational risk exposure. Many firms thus face having to invest heavily in new systems and processes to achieve a truly integrated risk management strategy.

"Before, risk was measured at the local level, but Basel II encourages an enterprise-wide view of risk," says Ron Denbo, chief executive of Algorithmics, a Canadian vendor of risk software.

Basel II allows financial institutions to delegate responsibilities for risk management. Because of the work involved, many are expected to turn to third parties to help meet the requirements of the new regulation.

Boutique consultancies, specializing in risk management, have sprung up in the past couple of years. Their target is the smaller institutions that cannot maintain a small army of risk specialists on their payrolls.

One such consultancy, New York-based Capital Market Risk Advisors, offers outsourcing capabilities in areas such as risk monitoring, vetting of risk models and quarterly reporting to investors or trustees.

Insurance companies have also jumped on the risk bandwagon with new policies specifically for operational risk mitigation. Not to be left out, the outsourcing industry has also changed its tune.

Outsourcing giants, such as EDS, now present outsourcing as a "risk mitigation tool". They argue that outsourcing can reduce operational risk by delegating the responsibility for running IT systems or entire business processes to providers with better track records.

Business process outsourcing is rapidly taking over IT outsourcing as the most significant segment of the marketplace. In the insurance sector, more than half of US insurers already outsource at least one business process. Treasury management is another BPO area where third-party providers such as Citibank and JMH Treasury have made big inroads.

The outsourcing of risk management itself seems the logical next step.
(June 30, 2003)

A Delicate Balance

In a recent study on hedge fund transparency and valuation, 80% of the funds of funds canvassed said they receive position-level information from their hedge fund managers. These funds of funds ranked the risk profile of their subfunds as the information most important to them, followed by position-level transparency.

The survey was conducted by Capital Market Risk Advisors Inc and the International Association of Financial Engineers. Participants in the study included institutional investors with $479 billion under management, funds of funds with $36 billion under management and individual hedge funds with $109 billion under management.

"The responses given by funds of funds are understandable," says Leslie Rahl, principal of CMRA. "Funds of funds wear two hats: They are both investors and funds. As a fund, their investors would like to receive information about overall portfolio risk, and there's really no way to do that unless they receive positions from their subfunds."

CMRA, which is in the business of providing risk solutions, doesn't offer a proprietary in-house system or favor an outsourcing provider "They all have their pluses and minuses, and it depends on the strategy and the complexity of that strategy," says Rahl. "We work with an in-house system a fund already has in place, or help it select one. But we really take a broader view of risk management, and focus on the questions that need to be asked and how funds can best interpret the data their systems provide."
(May 2003)

In Brief: Capital Market Risk Hires Ex-Citi Lawyer

NEW YORK -- Capital Market Risk Advisors Inc., a risk management advisory firm, hired a former Citicorp general counsel as a partner Monday.

Barbara Lucas, a partner in Cadwalader Wickersham & Taft and former chairwoman of its banking department, is to offer consulting, compliance, educational, and other services to corporate boards and managers, plan sponsor trustees, mutual fund boards, hedge fund managers, counsel, and compliance employees.

During her tenure at the law firm, Ms. Lucas represented major U.S. and foreign banks, broker-dealers, derivatives companies, and hedge funds on a wide range of bank regulatory, securities law, and corporate issues.

Previously, she was general counsel to the investment banking unit of what was then Citicorp, with responsibility for oversight of all legal and compliance functions in Citi's wholesale securities, commodities, derivatives, structured finance, and foreign currency businesses. Capital Market Risk Advisors is a financial advisory firm.
(May 20, 2003)

Capital Market Risk Advisors Hires Partner, Plans Fund of Funds

Capital Market Risk Advisors, a risk management advisory firm, has hired Barbara Lucas as a partner, the firm announced yesterday. In her new position, Lucas, a securities and banking lawyer, will offer consulting, compliance, educational, and other services to corporate boards and managers, mutual fund boards and hedge fund managers, according to Lucas.

In addition, Lucas will work with L2, an asset management and consulting firm launched last month by CMRA founder Leslie Rahl and Lisa Polsky.

L2 will soon launch a fund of funds, Lucas said, declining to further elaborate on its details.

Rahl and Polsky co-headed derivatives from 1986 to 1991 at Citibank. Since leaving Citibank 12 years ago, Polsky has headed hedge funds for Bankers Trust and has been chief risk officer of Morgan Stanley.

"Lisa, Leslie and I worked together at Citibank," Lucas said. "We're war horses of the business and we share a common view of how things should be managed."

Lucas was previously a partner in Cadwalader, Wickersham & Taft, where she chaired the firm's banking department, representing major U.S. and foreign banks, broker-dealers, derivatives companies and hedge funds on a wide range of bank regulatory and securities law, according to a press release. Lucas also worked as chief counsel to the Commodities and Futures Trading Commission's division of enforcement and director of its office of policy review.
(May 15, 2003)

Capital Market Risk Advisors, the US-based risk management firm set up by Leslie Rahl, former head of derivatives at Citibank, has a veteran hedge fund lawyer as a partner. Barbara Lucas has over 25 years of legal experience, and will offer consulting, compliance, educational, and other services to hedge fund managers as well as corporate boards and managers, plan sponsor trustees and mutual fund boards.

Lucas will also work with L2, the asset management consulting firm established last month by Rahl together with Lisa Polsky, her former co-head of derivatives at Citibank.

Lucas was formerly a partner at Cadwalader, Wickersham & Taft, a US law firm where she chaired the firm's banking department, representing hedge funds, banks, broker-dealers and derivatives companies on a wide range of regulatory, securities law and corporate issues.

Before joining Cadwalader, Lucas was general counsel to what was then known as Citicorp's Investment Bank, with responsibility for oversight of all legal and compliance functions in its securities, commodities, derivatives, structured finance and foreign currency businesses in the US and OECD countries.

She also served as chief counsel to the Commodities and Futures Trading Commission's division of enforcement and director of its office of policy review.
(May 15, 2003)

Making risk transparency a practicality

The hedge fund industry is being shaken by the hot debate around risk transparency. This controversy is symptomatic of the growing interest of institutional investors in alternative investments. Their demand for risk transparency is legitimate. They need it to view the risk profiles of each of their investments and to match their own risk profile to their liabilities. They also view it as a way to control their exposure to possible hedge fund defaults.

To address this demand, part of the hedge fund industry appears ready to alter one of its golden rules - maintaining the confidentiality of trading positions. These positions would not directly be transferred to the investor, but they would be collected and aggregated by a third party through the web using application service provider (ASP) technology. This third party would produce "fair" risk reports for each institutional investor.

Not all the hedge fund community shares this view and the dissenters are receiving backing from heavyweight investors. Mark Anson, chief investment officer at the California Public Employees' Retirement System (Calpers) and a member of the Investor Risk Committee's (IRC) steering group, said recently: "Transparency is an issue for all investors. However, there must be a balance between the disclosure of meaningful information to investors and the protection of a hedge fund manager's proprietary investment knowledge."

The IAFE Hedge Fund Transparency and Valuation Survey in January showed 66% of investors and 72% of hedge funds believe disclosing detailed positions can compromise a hedge fund's performance.

ASP proponents argue they are fully independent and that they are using best practice to protect the confidentiality of positions. The challenge then, in turn, is to protect the ASP - a place where much sensitive information is concentrated against any fraudulent behavior.

To a certain extent, whatever the technical answer delivered to those who want to protect business-sensitive information, the question remains: how far is positional transparency a relevant answer to the growing demand for risk transparency?

Building a risk report based on a record of all the positions could appear as the best way to deliver a relevant predictive analysis. The problem is, which positions?

Investors are generally locked in hedge funds for a minimum of one month. Within this timeframe the way a manager reacts to market events can crucially mitigate or amplify the risk and change the fund's exposure. Investors agree equity risk does not simply result from an analysis of a company's balance sheet, but is also driven by its culture and management's ethos and skills.

Why should the picture be different for hedge funds, where the whole point is that one does not invest in a certain combination of predetermined positions, but in managers' proven skills to run strategies dynamically? Added to this, positional transparency does not address another important issue for risk transparency, namely keeping the risk of hedge fund default under control. On the contrary.

Default risk reduction can be ensured only if a hedge fund is implementing effective in-house risk management - capable on a trade-by-trade basis to measure, explain and understand its risk. That cannot be obtained by a third party: this requires understanding and fine tuning of the specific drivers of each strategy, identifying the risks a manager wishes to run and the ones that should be neutralized.

For these reasons, positional transparency can quickly turn out to be a formal and costly exercise, one driven by pure marketing considerations without really addressing the demand for effective risk transparency.

Several recent surveys and studies, including Hedge Fund Risk Transparency: Unraveling the Complex and Controversial Debate by Leslie Rahl, have demonstrated positional transparency is ultimately the wrong approach to managing risk for hedge fund investments, and the industry has a clearer picture of what is required for effective risk transparency.

First, this requires an effective in-house risk-management capability, ensuring managers have a clear trade-by-trade control of the risk profile. The transparency of this capability can be ensured through the rating of in-house procedures by an independent third party. Second, a risk report must deliver risk figures, such as ante volatility or Value at Risk and also the exposure to few relevant factors specific to each strategy and investment style.

It is impossible to understand clearly the volatility arbitrage risk profile without a clear view of its exposure to market volatility.

Third, a powerful investigative tool is needed to extract all possible quantitative information contained in the past return series, capturing managers' impact on the risk profile.

One point this debate demonstrates to the industry is that these few minimum requirements make risk transparency practical and affordable. It does not require the creation of a costly, formal and inflexible industry standard.
(May 11, 2003)

Rahl and Polsky reunite at L2

Wall Street veterans Leslie Rahl and Lisa Polsky have teamed up to launch L2, a new breed of hedge fund consultancy. The service aims to go beyond providing traditional risk consulting, strategy selection and valuation capabilities by offering to manage client portfolios post structuring. Customization, greater education and more comprehensive risk management will also be key focal points of the new company. L2 forms an extension of Rahl's existing hedge fund advisory boutique, Capital Market Risk Advisors, which she founded in 1994. CMRA offers a range of risk management consulting services including due diligence, hedge fund manager selection, risk management outsourcing, budgeting and governance, new product development and financial forensics.

Rahl and Polsky first met at Citibank, where they coheaded its derivatives business between 1986 and 1991. Rahl spent 19 years at Citibank, including nine as head of the firm's derivatives group in North America. During this time, she has been credited with launching Citibank's caps and collars business in 1993 as an extension of the proprietary options arbitrage portfolio she previously ran. Polsky was most recently a managing director at Merrill Lynch, where she headed collateralized financing services including prime brokerage, swaps, repo, stock loan and margining. Prior to that she was a managing director with Morgan Stanley, overseeing global risk, credit and insurance for the firm.
(April 2003)

CMRA Adds Institutional Investor Arm

Capital Market Risk Advisors president Leslie Rahl has teamed up with Morgan Stanley Chief Risk Officer Lisa Polsky to create a joint venture called L2. An added component of CMRA's current consulting practice, L2 will offer institutional investors more customization, education and improved risk management to increase their investments in the hedge funds, funds of funds and other alternatives.
(March 31, 2003)

Leslie Rahl and Lisa Polsky to Reunite and Form L Squared

L Squared is a joint venture and reunion between derivative and hedge fund pioneers Leslie Rahl and Lisa Polsky. Leslie and Lisa co-headed derivatives from 1986 to 1991 at Citibank and were frequently referred to as L2 because of their fungibility and their exponential value added as a team. Since leaving Citibank 12 years ago, Leslie has been President of Capital Market Risk Advisors, Inc. (CMRA) - the preeminent risk management advisory boutique while Lisa has headed hedge funds for Bankers Trust and has been chief risk officer of Morgan Stanley, and ran Prime brokerage for Merrill Lynch. Capital Market Risk Advisors and Lisa Polsky Partners have created this joint venture to pursue their mutual belief that institutional investors are going to require more customization, more education and better risk management to increase their investment in the hedge funds, funds of funds and other alternatives. This joint venture is anticipated to complement an existing consulting practice of CMRA.
(March 24, 2003)

Citibank derivatives veterans reunite to form consultancy

Leslie Rahl and Lisa Polsky, former co-heads of derivatives at Citibank, have reconvened to form a new consultancy and derivatives consultancy called L2. Rahl and Polsky co-headed derivatives at Citibank from 1986 to 1991.

Since leaving Citibank, Rahl has been president of Capital Market Risk Advisors (CMRA), the risk management advisory boutique, while Polsky has headed hedge funds for Bankers Trust and has been chief risk officer of Morgan Stanley. She also ran prime brokerage for Merrill Lynch.

Capital Market Risk Advisors and Lisa Polsky Partners have created the joint venture to pursue their "mutual belief that institutional investors are going to require more customization, more education and better risk management to increase their investment in the hedge funds, funds of funds and other alternatives", according to a statement.

Rahl is widely regarded as a pioneer of the swaps and derivatives business and was the originator of the interest rate cap, collar and floor business. Prior to forming CMRA, she was president of Leslie Rahl Associates, a consulting firm specializing in swaps, options and derivative products.

She spent 19 years at Citibank, including nine years as head of its derivatives group in North America.
(March 21, 2003)

L SQUARED LAUNCHED

L Squared is a joint venture between derivative and hedge fund pioneers Leslie Rahl, principal of Capital Market Risk Advisors, and Lisa Polsky, principal of Lisa Polsky Partners. Rahl and Polsky created L Squared to pursue their belief that institutional investors will require more customization and education and better risk management to increase investment in hedge funds, funds of funds and other alternatives.

Rahl and Polsky co-headed derivatives from 1986 to 1991 at Citibank, and were frequently referred to as L-squared because of their fungibility and their exponential value-added as a team. Since leaving Citibank 12 years ago, Rahl has been president of CMRA, a risk management advisory boutique, while Polsky has headed hedge funds for Bankers Trust and been Morgan Stanley's chief risk officer.
(March 20, 2003)

Hedge Funds Increasingly Present in Derivatives World

Luis Rodriguez, a consultant at Capital Markets Risk Advisors, said that credit derivatives' lack of liquidity makes it difficult to use them as a hedging instrument and receive favorable accounting treatment. But to use the increasingly complex instruments as speculative investments requires assembling research and risk management teams, creating a barrier to enter the credit derivatives market and ultimately resulting in greater concentrations of risk. Among those market participants that may not have the resources to overcome that barrier to entry and properly manage their risks is the unregulated hedge fund community, which has become a rapidly growing player in the credit derivatives market.

"Because hedge funds are unregulated, nobody knows to what extent they're involved in the market and what their exposure is. The whole point here is risk is being transferred, not to the hedge fund, but to the end investors [in the hedge fund], so do they understand what risk they're taking or all of a sudden will they confronted by a situation with no way out?" Rodriguez stated. He pointed to Long Term Capital Management's demise, and the tendency to blame uncontrollable outside events rather than the firm's own risk management practices.

Rodriguez described credit derivatives as important tools to management credit risk, but said they also expose users to liquidity, counterparty and legal risk, with operational risk -stemming mainly from trading the instruments - probably the most dangerous one.

"That's why hedge funds play an important role, because nobody knows if they're speculating," Rodriguez said.
(March 17, 2003)

Risk and Transparency: How Much Do You Want?

The word "risky" gets used a lot after a hedge fund fails. When Long-Term Capital Management collapsed in 1998, reporters became entrenched in their habit of describing hedge funds as risky. In the past year or so, several high profile failures sparked debates as to whether these managers had taken excessive risk. "Risk management queried," ran a headline about Beacon Hill, the mortgage-backed securities firm that suffered heavy losses and stopped managing funds in late 2002.

Its ubiquity has not made the concept of risk easier to grasp, partly because the idea is not very useful on its own and partly because it has so many facets. It needs to be taken in relation to other considerations such as expected return. "I don't know how to make money without taking risk," points out Leslie Rahl, President of Capital Market Risk Advisors. "As long as you have an understanding of the risk and a realistic measure for it, I don't see a problem. You don't get rid of risk because then you wouldn't make money."

Risk and Reward
The key issue is where an investor wants to be on the risk and return tradeoff. Do you want to take a potential return of 20% at higher risk or 8% at lower risk? "Neither one is better than the other-they are different and investors should have a clear understanding of the tradeoff," said Rahl. "They should not think they're getting the same risk with the 20% investment as with the 8%."

Dealing effectively with risk requires not only measuring it but also integrating it into decision making. Risk budgeting, a systematic way of thinking of asset allocation in terms of risk, incorporates the tradeoff. How much risk are you taking in a given investment class relative to the return that you expect to achieve? How much of assets should be in more volatile investments and how much in more stable, less risky investments?

Advisors like Rahl have been using the approach in structuring portfolios. A large pension fund, Ontario teachers' Pension Plan, has for years been budgeting risk and allocating it among portfolio managers. Leo de Bever, senior vice president for research and economics at the pension, may be the most experienced person around in risk budgeting.

Ontario teachers uses Value at Risk to track both market risk and active risk-the danger of underperforming a passive market benchmark. The pension sets an active risk budget every year. Alternative investments have a growing share of this, in pursuit of absolute return on risk. The pension uses some 130 hedge funds with a diverse range of strategies. All performance is evaluated in terms of return on risk.

Improved technology has made it simpler to process the information for this type of approach. "Monitoring and measuring risk has become easier in past few years," said Virginia Parker, president of Parker Global Strategies. "Systems are better, there are a number of software options for running risk analytics, costs has gone down, and reports from brokers have improved. It is now easier for allocators to get a better grasp on risk measurement analytics."

Nevertheless, this remains a complicated endeavor, as books on the subject by Parker and Rahl demonstrate. A look at Managing Hedge Fund Risk by Parker and Risk Budgeting by Rahl reveals many complexities, from relatively little known risks that are specific to certain hedge strategies to the dangers of historical data. Foremost among these issues are how to measure risk and the data necessary for effective measurement.
(February 5, 2003)

IRC HEDGE FUND TRANSPARENCY AND VALUATION SURVEY
View Article

The Investor Risk Committee (IRC) of the International Association of Financial Engineers (IAFE) and Capital Market Risk Advisors, Inc. (CMRA) has recently released the results of a survey of institutional investors, hedge funds, and funds of funds on Hedge Fund Transparency and Valuation practices. Both AIMA and 100 Women in Hedge Funds also supported the survey.

Participants included institutional investors with $479 B in capital under management, funds of funds with $36 B in capital under management and individual hedge funds with $109 B capital under management. Mark Anson, CIO of CalPERS and a member of the IRC Steering Committee said "Transparency is an issue for all investors. However, there must be a balance between the disclosure of meaningful information to investors and the protection of a hedge fund manager's proprietary investment knowledge. The Investor Risk Committee conducted this survey as a step towards striking the appropriate balance."

Survey Key Findings

• Investors, funds of funds and individual hedge fund managers appear to agree, in general, that it depends on strategy whether or not disclosure of position level data compromises the performance of a fund. Meanwhile, the percentage of participants who believe that it has a "significant or material impact" varies significantly by participant type.
• 95% of both funds of funds and individual hedge funds provide "risk profiles", whereas only 72% of funds of funds and 57% of hedge funds provide stress test results to their investors
• While both investors and funds of funds would allocate the largest percentage of a "risk information budget" to risk profiles, investors are much less interested in position-level detail than are funds of funds.
• 80% of funds of funds, compared to only 13% of investors, indicate that they receive position-level information from their hedge fund managers.
• Approximately one-third of funds of funds and hedge funds report that their investors request more information than they are willing to supply.
• Individual hedge funds indicate that the percent of NAV marked at midpoint is higher than the percentage assured by investors and funds of funds.
• 50% of investors and 20% of funds of funds don't know whether their funds are making any adjustments to NAV
• Both investors and funds of funds would spend the largest allocation of a "100 point budget for transparency" on position-level detail; investors would allocate their second highest "budget" to "percentage marked to model"; and funds of funds would select "manager's valuation practices" as their second most important priority.
• 94% of funds of funds versus 50% of investors, receive details of most or all of their hedge funds' valuation policies.

(February 2003)

Hedge Fund Transparency: Unraveling the Complex and Controversial Debate
Presented by Leslie Rahl, President, Capital Market Risk Advisors, Inc.

Leslie Rahl will present the natural conflict between hedge funds and their investors and explain the reasons behind the tug of war. She will suggest some proactive approaches to bridge the gap and discuss the work of the Investor Risk Committee (IRC) of the International Association of Financial Engineers (IAFE) on both transparency and valuation.

Ms. Rahl will emphasize that while numbers are important, their importance pales in comparison to effective, ongoing, due diligence and intelligent manager selection and emphasize the value added that Capital Market Risk Advisors, Inc. (CMRA) has found from both the qualitative and quantitative in its development of customized funds of funds. An eyeball-to-eyeball approach is required and due diligence must be performed by someone not only knowledgeable in the underlying strategy, but also wise to the "ways" of hedge fund managers and skilled at peeling the onion and probing deeply when needed.

She will share some of the "perspectives" offered by the 26 institutional investors, funds of funds and individual hedge funds that contributed to her new book, and share examples of due diligence findings from CMRA reviews that demonstrate the benefits of "expert" due diligence. Ms. Rahl will emphasize that while the qualitative factors are paramount, due diligence and manager selection are enhanced by a rigorous, disciplined approach and share her "risk puzzle" as well as good general risk questions for beginning a dialogue.

Ms. Rahl also will discuss the "galaxy" of risks, the various ways risk can be measured, and the importance of developing a risk management framework that is consistent with organizational philosophy.
(February 24, 2003)

News - Investors see templates as transparency solution.

Hedge funds are attempting to create a series of reporting templates to address concerns from institutional investors about a lack of transparency in position level reporting.

A survey shows that while a third of investors still believe that the release of detailed figures would not compromise performance, two-thirds now accept that there are potential risks.

Institutional investors are thought to be the least likely to accept limits on disclosure because many come from long-only equity backgrounds, and so do not understand the dangers of disclosing short positions to the market.

The survey, compiled by the International Association of Financial Engineers (IAFE) and Capital Market Risk Advisors, shows that just a quarter of hedge funds believed that position-level disclosure had minimal or no impact.

However, almost a third of hedge funds said disclosure had a significant or material impact, while 44 per cent said it depended on strategy.
(January 27, 2003)

Big Hedge-Fund Investors Seek Greater Disclosure

NEW YORK -(Dow Jones)- Despite a general consensus on the need for greater transparency in the hedge-fund industry, fund managers still disagree with their biggest investors on just how much information they need about their portfolios.

That's the conclusion of a survey released this week by the International Association of Financial Engineers, an industry trade group, and Capital Market Risk Advisors Inc., an investment adviser specializing in hedge funds.

Approximately one-third of the hedge funds surveyed said their investors request more information than they are willing to supply.

Hedge funds - loosely regulated investment pools that cater to the wealthy - are largely exempt from the reporting requirements mutual funds face. Many are loath to disclose their holdings in too much detail, because they deal in illiquid securities or trade in and out of positions frequently.

But some hedge funds are becoming more open in order to attract investment from big institutions. IAFE's Investor Risk Committee, which includes both managers and investors, surveyed its members as part of an effort to benchmark industry practices.

Institutional investors with a combined $479 billion under management participated in the survey, as did individual hedge funds with $109 billion under management and fund of hedge funds with $36 billion under management.

Not surprisingly, hedge funds are more inclined than their investors to think that providing information about individual holdings can compromise a fund's performance.

Thirty-two percent of fund managers said such information has "a significant or material impact" on fund performance, while another 44% said the impact depends on a fund's strategy and 24% said it had minimal or no impact.

By comparison, 11% of fund of hedge funds respondents said disclosing detailed, position-level data compromises performance, and another 55% said it could compromise performance, depending on a fund's strategy.

But none of the investors responding to the survey agreed that disclosing such information has a significant impact on performance, while 66% said the impact depended on a fund's strategy.

Despite disagreements about the appropriate level of disclosure, 69% of hedge funds surveyed provide investors with some information about individual holdings, while another 8% provide this information, but only to investors who stop by their offices. Another 23% do not provide any information about individual holdings at all.

Among funds that invest in other hedge funds, 47% provide position-level detail, another 12% provide it but only in the office and 41% don't provide it at all.

Hedge funds are more likely to provide general information about the risk of investing in a fund than detailed information about holdings. Ninety-six percent of hedge funds respondents said they provided "risk profiles," while only 4% provide no such information.

Among fund of hedge funds, 95% of respondents provide investors with "risk profiles," while the remaining 5% provide this information, but only to investors who stop by their offices.

Efforts to hash out a disclosure framework for the hedge funds come as regulators are pushing for greater openness in the mutual fund industry. The Securities and Exchange Commission voted Thursday to compel mutual funds to tell investors how they vote shares of stock in their portfolios.
(January 23, 2003)

Investors and Funds of Funds View Transparency Differently

NEW YORK—Institutional investors, funds of funds and hedge managers have differing priorities and views with regard to information disclosure, according to a survey by the International Association of Financial Engineers and Capital Market Risk Advisors.

"There are still substantial differences of opinion," said Leslie Rahl, a co-chair of the IAFE Investor Risk Committee and president of CMRA. "Many responsible people are doing things differently."

One difference is in transparency regarding how managers mark their positions. The survey indicates that 94% of funds of funds receive details of most or all the valuation policies of hedge funds in which they invest, while only 50% of institutional investors in hedge funds do.

There are complex issues in valuation, such as marking at the mid-point versus marking long positions at bid and short positions at offer, explained Ms. Rahl. The value of assets varies with the method used. "It is not that one approach is better than the other," she said, "but if you were comparing two funds, you would certainly want to know if you are comparing apples to oranges."

Another difference is that institutional investors in hedge funds are less interested in position-level data than funds of funds. Only 13% of investors receive such information, in contrast to 80% of funds of funds.

Asked how they would like to allocate a given risk information budget, both funds of funds and investors said they would allocate the largest percentage to risk profiles. But funds of funds gave almost as much importance to position level transparency, while institutional investors allocated the fewest points to this.

Of the three groups, hedge fund managers were the most concerned that disclosing position-level data might compromise a fund's performance, with 32% replying that there is a significant or material impact. But only 11% of funds of funds managers said there is such an effect. Most institutional investors (66%) and funds of funds (55%) said this depends on the strategy.

Investors do not necessarily get the data they ask for. About one-third of the funds of funds and hedge funds in the survey report that investors request more information than they are willing to supply.
(January 21, 2003)

Hedge funds provide poor stress-testing disclosure, says IAFE

Hedge funds offer poor stress-testing results and ‘greeks' disclosure to third parties, according to a new survey by the International Association of Financial Engineers (Iafe).

Only 57% of hedge funds polled by Iafe's Investor Risk Committee (IRC), in conjunction with New York-based consultancy Capital Market Risk Advisors, offered disclosure on stress-test results, compared with 72% of funds of funds. But funds of funds had a weaker performance on ‘greeks' disclosure with only 44% offering such information compared with 57% of hedge funds. Greeks are used for measuring and creating hedging strategies.

The survey also found that the majority of investors and funds of funds believed position-level disclosure would only affect the performance of certain types of hedge fund strategies. But 32% of hedge funds believe such transparency would have a significant or material impact on hedge fund performance.

Mark Anson, chief information officer at Californian pension fund Calpers and member of the IRC's steering committee, said a balance was needed regarding hedge fund disclosure. "Transparency is an issue for all investors," Anson said. "However, there must be a balance between the disclosure of meaningful information to investors and the protection of a hedge fund manager's proprietary investment knowledge."

For example, investors place more emphasis on risk profile and stress-test results than on position-level transparency. But funds of funds placed an equal emphasis on these two areas of disclosure. The survey found that 80% of funds of funds and 13% of investors received position-level information. That said, a third of funds of funds and hedge funds said investors request more information than they are willing to provide.

Survey participants included institutional investors with $479 billion of assets under management, funds of funds with $36 billion under management and hedge funds with $109 billion under management.
(January 16, 2003)

Hedge Fund Investors Press for Disclosure

The issue of transparency has already emerged as a significant theme for plan sponsors in 2003.

While the issue has been a source of concern in previous years, recent scandals shuttled the topic to the forefront of investors' minds.

A separate survey conducted by the investor risk committee of the International Association of Financial Engineers and Capital Market Risk Advisors found that while all participants agreed that disclosing information can compromise the performance of the fund, responses varied in terms of the significance of the impact.

The hedge fund transparency and valuation survey polled institutional investors, in addition to fund-of-funds and individual hedge funds.

Of the institutional investors surveyed, none felt that disclosure would have a significant or material affect on fund performance, although 66% agreed that any changes would depend on strategy.
(January 20, 2003)

Full transparency not a hedge fund panacea

The IRC meetings were chaired by Capital Market Risk Advisors' Leslie Rahl, author of a soon-to-be published book on hedge fund risk transparency. According to Rahl, we can expect to see the first fruits of the committee's work sometime this month, in the shape of risk reporting standards for the first couple of hedge fund strategies. The rest are due in the second quarter.

Rahl is increasingly convinced that position-level transparency should be replaced by the notion of 'translucency', in which, according to her book, "a standard set of risk factors can provide investors with a meaningful snapshot of a hedge fund's risk". The author maintains "this is, in fact, the implicit but sometimes unarticulated goal of investors."

No panacea
In an interview with FOW, Rahl adds "position-level transparency is not a panacea - and I am a detail-oriented person". Citing merger arbitrage as an example, she says, "If you looked at the portfolio you would see longs and shorts of various stocks, [but not] the 'off balance sheet' event put option embedded in such a strategy. Analysing the positions would require a level of sophistication on the part of the investor; you would need to know the 'why'."

According to her book, IRC members agree that full position disclosure by managers does not always allow them to achieve their monitoring objectives and may compromise a hedge fund's ability to execute its investment strategy. On the other hand, there does not appear to be a suitable, "one size fits all" risk template, even for more straightforward strategies such as equity long/short. As IRC continues its more detailed work, including suggestions for risk profiles by type of hedge fund strategy and the related needs of institutional investors, it will generate a standard industry approach to risk profiling and counting, and an analytical approach to aggregate information.

Summary information
The committee has suggested that summary information should be evaluated on four dimensions: content (information about the risk, return, and positions on both an actual and a stress-tested basis); granularity (the level of detail, such as disclosure of NAV, risk factors such as VaR, tracking error and so on); frequency (high turnover strategies may require more frequent disclosure, for example) and delay (the lag between a fund event and disclosure).

IRC also believes that an alternative nomenclature, using asset class, direction, type, region, liquidity and turnover, might eventually replace the current styles classification and provide a more useful framework for discussion and comparison. Under such a scheme one technology fund e classified as "stocks-long/short-US-highly liquid" , while a Japanese distressed debt fund would be "bonds-event-distressed-Japan-illiquid".

Neither is Rahl a complete advocate of such solutions as risk providers like RiskMetrics and Reech Capital provide, both of which have developed services to give risk reports for hedge fund investors while maintaining secrecy on behalf of the fund itself. In one study reported by the author, over 80% of funds would like to provide the information to investors through their own internal system. There are several bottom lines here, one of which is that managers will say no product can be broad enough to cover all strategies or sub-strategies, and therefore that the result is inevitably going to be a compromise. Another is, quite simply, traders. Don't they trust their service providers?

"Look," says Rahl, "I was a trader for ten years and when it comes down to disclosing 'proprietary' information, the bottom line is, don't confuse me with the facts! It's just a hard barrier to break."

IRC's task has involved trying to account, as it does, for the views of a commit tee of 300-odd people, representing hedge funds, funds of funds and investors. Some of these, often contrasting, views are also outlined in panel interviews in Rahl's book.
(January 2003)

In an attempt to find a balance between disclosure of information to investors and the protection of a hedge fund manager's proprietary investment knowledge, the investor risk committee of the IAFE and Capital Market Risk Advisors surveyed institutional investors, hedge funds and fund of funds.

Topping the list of transparency information provided to investors was risk profiles. About 95% of the fund of funds and 96% of the hedge funds provided these. Stress tests were provided by 72% of the fund of funds but only by 57% of the hedge funds. Hedge funds were more comfortable providing VAR; about 78% of the hedge funds provided VAR to clients compared with only 67% of the fund of funds that did. Position-level details were at the bottom of the fund of funds' list. Only 47% of the fund of funds provided these while 69% of the hedge funds did.

Other highlights included:

80% of the fund of funds said they receive position-level information from their hedge fund managers while only 13% of investors said they receive such information.

About one-third of fund of funds and hedge funds report that their investors request more information than they are willing to supply.

50% of investors and 20% of fund of funds don't know whether their funds are making any adjustment to net asset value.

94% of the fund of funds receive details on most or all of their hedge fund valuation policies while only 50% of investors do.
(January 2003)