Holistic Risk Budgeting

Richard Horwitz

Investors, both directly and through their underlying investments, are exposed to a large number of risks. Most investors do not have the information, resources, capabilities or expertise to manage all of these risks. Furthermore, many investors are not even aware of all of the risks to which they are exposed. For example, the “Principles and Best Practices for Hedge Fund Investors, Report of the Investors’ Committee to the President’s Working Group on Financial Markets” suggests that investors should do the following.

• Assess the hedge fund manager’s reliance on models, including assumptions, model inputs and risks associated with the models the manager employs.

• Assess the expected frequency of material and substantive model changes, and whether the manager intends to notify investors when such changes are made.

• Assess whether the fund’s service providers have sufficient experience and independence to perform their roles effectively, are not exposed to undue influence from the manager, and that the compensation and other terms of service-providers engagements do not give rise to potential conflicts of interest.

• Understand the financing arrangements of the fund and