The hedge fund model obviates the need to access portfolio holdings information, by using step-wise regressions to determine the portion of fund’s returns explained by known factors, such as equity, fixed-income, currency and commodity exposures. It also accounts for time-dependent information, such as changes in geography concentrations and changes in trading strategies.
Hudacko added that for long/short equity hedge funds, most risks can be explained by equity factors. However, for convertible arbitrage, managed futures or distressed debt funds, their trading behaviour plays a key role in explaining risk exposures. This means that a more complex risk model than a simpler index-based approach is needed.
However, the model has certain limitations, due to the lack of transparency into most hedge funds. “The investor typically doesn’t have transparency into the portfolio, so we don’t have clear information such as non-linearity in the portfolio, what positions the hedge funds have, or information about their liquidity. The model is designed primarily to pick up market and alternative systematic risks, but there are other risks outside of these that may become highly significant in times crisis," said Hudacko.
The week on Risk.net, December 2–8, 2016Receive this by email