Risk management emerges as a competitive focus area for hedge funds

Risk management has always been a core component of any trading strategy, as well as a critical part of business management. However, as macreconomic weakness persists, and alpha becomes increasingly hard to generate, risk management as emerged as a more prominent competitive metric. industry members gathered at the Professional Risk Managers international Association's (PRMIA) Risk Year in Review to discuss that evolution and risk factors for 2015.

Panelists noted that risk management is likely to continue evolving into a core metric for competitive advantage as the buyside works to deal with a challenging macroeconomic situation and an unclear market environment. Where risk management may have triggered a sell signal before, the risk group is now tasked with managing that as well as business risk and keeping traders in the loop on how this may impact strategy. This is in part due to the institutionalization of funds, as investor demand is making risk management a more high profile position. But it is also important as compliance concerns and unique market conditions put more pressure on hedge funds operationally.

Interest rates

Much of rest of the discussion focused on macroeconomic events including how a rise in interest rates in the US could effect markets. "We are likely to see interest rates rise middle of next year and we could see as many as three increases before the end of the year, according to our research," said Dana Saporta, Director of US Economics Research at Credit Suisse.

Despite that prediction, Saporta also noted that markets are unlikely to see the Fed funds rate reach neutral this decade. Both wage stagnation in the US and the potential for a sharper than expected slowdown in the global economy will also be downside risks to watch out for moving into 2015.

"I think people have to realize that the volatility we saw in 2014 has structural underpinnings. The world trades different than we do in the US, and those correlations are creating a binary market," added Robert Savage, CEO at Track Research. "I think what people saw in October was that the US bond market isn't as deep as everyone thinks it is. As things change, people will have to manage that reality."

Wage inequality

Another risk factor outlined among panelists was the continued wage stagnation in the US. "I think people are realizing their freedom isn't working out as well for them as they'd like," said Jim Bacchus, Chair of the Global Practice at Greenberg Traurig "Outside of the major hubs like New York, people have little trust in the stock market. They have little trust in banks. Everything they worked for could be gone in an instant, and they aren't making what they used to. They also aren't making anything on what they save. There's a human factor to all this and it's a real problem."

Panelists also noted the role of student loans and their impact on young people being able to live on their own even if they have a job. This part of the equation is unique to the US economy and could prove to be an additional threat to growth if loan default rates continue to rise, or housing starts drop off.

Compliance

Going forward, compliance issues will also continue to play a central role right alongside economic concerns. A handful of issues around market structure and collateralization are proving to be challenging as implementation gets under way. "Cost of collateralization is an issue event without interest rates," said Saporta. "I think you're starting to see regulators admit some of the unintended consequences of the regulations that have been implemented so far, but the costs are high."
Others noted additional risks including the quality of what are supposed to be AAA securities. "I think one of the weaker parts of the market when you're talking about collateralization is the futures market. People think margin is enough may be surprised if we have another big event," Savage said.

Bailey McCann, Opalesque New York: http://www.opalesque.com/653425/Risk_management_emerges_as_a_competitive_focus_area342.html