Topics 69-71

Question 1

Define, compare, and contrast VaR and tracking error as risk measures

Answer 1

• Tracking error is defined as the standard deviation of excess returns. Excess return is defined as the portfolio return less the benchmark return (i.e., alpha).
• VaR may be used to suggest the maximum dollar value of losses for a specific level of confidence over a specific time. From a portfolio management perspective, VaR could be determined for each asset class, and capital allocation decisions could be made amongst the asset classes depending on risk and return preferences. This will help to achieve targeted levels of dollar VaR. In contrast, tracking error may be used to determine the relative amount of discretion that can be taken by the portfolio manager (away from benchmark returns) in his or her attempts at active management.

Question 2

Describe risk planning, including its objectives, effects, and the participants in its development

Answer 2

There are five risk planning objectives for any entity to consider.

1. Setting expected return and expected volatility goals.
2. Defining quantitative measures of success or failure.
3. Generalizing how risk capital will be utilized to meet the entity’s objectives.
4. Defining the difference between events that cause ordinary damage versus serious damage. Specific steps need to be formulated to counter any event that threatens the overall longterm existence of the entity, even if the likelihood of occurrence is remote. The choice between seeking external insurance (i.e., put options) versus self-insurance for downside portfolio risk has to be considered from a cost-benefit perspective, taking into account the potential severity of the losses.
5. Identifying mission critical resources inside and outside the entity and discussing what should be done in case those resources are jeopardized.

Question 3

Describe risk budgeting and the role of quantitative methods in risk budgeting

Answer 3

Quantitative methods (i.e., mathematical modeling) may be used in risk budgeting as follows:

1. Set the minimum acceptable levels of RORC and ROE over various time periods. This is to determine if there is sufficient compensation for the risks taken (i.e., risk-adjusted profitability).
2. Apply mean-variance optimization (or other quantitative methods) to determine the weights for each asset class.
3. Simulate the portfolio performance based on the weights and for several time periods. Apply sensitivity analysis to the performance by considering changes in estimates of returns and covariances.

Question 4

Describe risk monitoring and its role in an internal control environment

Answer 4

Within an entity’s internal control environment, risk monitoring attempts to seek and investigate any significant variances from budget. This is to ensure, for example, that there are no threats to meeting its ROE and RORC targets. Risk monitoring is useful in that it should detect and address any significant variances in a timely manner.

Question 5

Identify sources of risk consciousness within an organization

Answer 5

The increasing sense of risk consciousness within and among organizations is mainly derived from the following three sources:

1. Banks who lend funds to investors are concerned with where those funds are invested.
2. Boards of investment clients, senior management, and plan sponsors have generally become more versed in risk management issues and more aware of the need for effective oversight over asset management activities.
3. Investors have become more knowledgeable about their investment choices. For example, beneficiaries of a defined contribution plan are responsible for selecting their individual pension investments.

Question 6

Describe the objectives and actions of a risk management unit in an investment management firm

Answer 6

A risk management unit (RMU) monitors an investment management entity’s portfolio risk exposure and ascertains that the exposures are authorized and consistent with the risk budgets previously set. To ensure proper segregation of duties, it is crucial that the risk management function has an independent reporting line to senior management.

The objectives of a RMU include:

• Gathering, monitoring, analyzing, and distributing risk data to managers, clients, and senior management. Accurate and relevant information must be provided to the appropriate person(s) at the appropriate time(s).
• Assisting the entity in formulating a systematic and rigorous method as to how risks are identified and dealt with. Promotion of the entity’s risk culture and best risk practices is crucial here.
• Going beyond merely providing information by taking the initiative to research relevant risk topics that will affect the firm.
• Monitoring trends in risk on a continual basis and promptly reporting unusual events to management before they become significant problems.
• Promoting discussion throughout the entity and developing a process as to how risk data and issues are discussed and implemented within the entity.
• Promoting a greater sense of risk awareness (culture) within the entity.
• Ensuring that transactions that are authorized are consistent with guidance provided to management and with client expectations.
• Identifying and developing risk measurement and performance attribution analytical tools.
• Gathering risk data to be analyzed in making portfolio manager assessments and market environment assessments.
• Providing the management team with information to better comprehend risk in individual portfolios as well as the source of performance.
• Measuring risk within an entity. In other words, measuring how consistent portfolio managers are with respect to product objectives, management expectations, and client objectives. Significant deviations are brought to the attention of appropriate management to provide a basis for correction.

Question 7

Describe how risk monitoring can confirm that investment activities are consistent with expectations

Answer 7

Is the manager generating a forecasted level of tracking error that is consistent with the target?

Tracking error forecast reports should be produced for all accounts that are managed similarly in order to gauge the consistency in risk levels taken by the portfolio manager.

Is risk capital allocated to the expected areas?

Overall tracking risk is not sufficient as a measure on its own; it is important to break down the tracking risk into “subsections.” If the analysis of the risk taken per subsection does not suggest that risk is being incurred in accordance with expectations, then there may be style drift. Style drift may manifest itself in a value portfolio manager who attains the overall tracking error target but allocates most of the risk (and invests) in growth investments.

Therefore, by engaging in risk decomposition, the RMU may ensure that a portfolio manager’s investment activities are consistent with the predetermined expectations (i.e., stated policies and manager philosophy). Also, by running the report at various levels, unreasonably large concentrations of risk (that may jeopardize the portfolio) may be detected.

Question 8

Explain the importance of liquidity considerations for a portfolio

Answer 8

Measuring portfolio liquidity is a priority in stress testing. One potential measure is liquidity duration. It is an approximation of the number of days necessary to dispose of a portfolio’s holdings without a significant market impact. For a given security, the liquidity duration could be calculated as follows:

LD = Q / (0.1 x V)

where:

• LD = liquidity duration for the security on the assumption that the desired maximum daily volume of any security is 10%
• Q = number of shares of the security
• V = daily volume of the security

Question 9

Describe the objectives of performance measurement

Answer 9

Performance measurement seeks to determine whether a manager can consistently outperform (through excess returns) the benchmark on a risk-adjusted basis. Similarly, it seeks to determine whether a manager consistently outperforms its peer group on a risk-adjusted basis.

Performance measurement provides a basis for identifying managers who are able to generate consistent excess risk-adjusted returns.

Comparison of Performance with Expectations

• From a risk perspective (e.g., tracking error), portfolio managers should be assessed on the basis of being able to produce a portfolio with risk characteristics that are expected to approximate the target. In addition, they should also be assessed on their ability to actually achieve risk levels that are close to target.
• From a returns perspective (e.g., performance), portfolio managers could be assessed on their ability to earn excess returns.

Return Attribution

• The source of returns can be attributed to specific factors or securities. For example, it is important to ensure that returns result from decisions where the manager intended to take risk and not simply from sheer luck.
• Variance analysis is used to illustrate the contribution to overall portfolio performance by each security. The securities can be regrouped in various ways to conduct analysis by industry, sector, and country, for example.
• In performing return attribution, factor risk analysis and factor attribution could be used. Alternatively, risk forecasting and attribution at the security level could also be used.

Sharpe and Information Ratio

• Strengths of these metrics include the following: (1) easy to use as a measure of relative performance compared to a benchmark or peer group; (2) easy to determine if the manager has generated sufficient excess returns in relation to the amount of risk taken; and (3) easy to apply to industrial sectors and countries.
• Weaknesses of these metrics include the following: (1) insufficient data available to perform calculations; and (2) the use of realized risk (instead of potential risk) may result in overstated performance calculations.

Question 10

Describe the use of alpha, benchmark, and peer group as inputs in performance measurement tools

Answer 10

• One could use linear regression analysis to regress the excess returns of the investment against the excess returns of the benchmark. One of the outputs from this regression is alpha, and it could be tested for statistical significance to determine whether the excess returns are attributable to manager skill or just pure luck. The other output is beta, and it relates to the amount of leverage used or underweighting/overweighting in the market compared to the benchmark.
• Furthermore, there is the ability to separate excess returns due to leverage and excess returns due to skill. One limitation to consider is that there may not be enough data available to make a reasonable conclusion as to the manager’s skill.
• One could also regress the excess returns of the manager against the excess returns of the manager’s peer group. The features of this regression are generally similar to that for the benchmark, except that the returns of the peer group suffer from survivorship bias, and there is usually a wide range of funds under management amongst the peers (that reduces the comparability).

Question 11

Differentiate between time-weighted and dollar-weighted returns of a portfolio and describe their appropriate uses

Answer 11

The dollar-weighted rate of return is defined as the internal rate of return (IRR) on a portfolio, taking into account all cash inflows and outflows. The beginning value of the account is an inflow as are all deposits into the account.

Time-weighted rate of return measures compound growth. It is the rate at which $1.00 compounds over a specified time horizon. Time-weighting is the process of averaging a set of values over time. The annual time-weighted return for an investment may be computed by performing the following steps:

• Step 1: Value the portfolio immediately preceding significant addition or withdrawals. Form subperiods over the evaluation period that correspond to the dates of deposits and withdrawals.
• Step 2: Compute the holding period return (HPR) of the portfolio for each subperiod.
• Step 3: Compute the product of (1 + HPR_t) for each subperiod t to obtain a total return for the entire measurement period [i.e., (1 + HPR₁) x (1 + HPR₂) … (1 + HPR_n)]. If the total investment period is greater than one year, you must take the geometric mean of the measurement period return to find the annual time-weighted rate of return.

In the investment management industry, the time-weighted rate of return is the preferred method of performance measurement for a portfolio manager because it is not affected by the timing of cash inflows and outflows, which may be beyond the managers control.

If funds are contributed to an investment portfolio just before a period of relatively poor portfolio performance, the dollar-weighted rate of return will tend to be depressed. Conversely, if funds are contributed to a portfolio at a favorable time, the dollar-weighted rate of return will increase. The use of the time-weighted return removes these distortions, providing a better measure of a managers ability to select investments over the period. If a private investor has complete control over money flows into and out of an account, the dollar-weighted rate of return may be the more appropriate performance measure.

Question 12

Universe Comparisons

Answer 12

Portfolio rankings based merely on returns ignore differences in risk across portfolios. A popular alternative is to use a comparison universe. This approach classifies portfolios according to investment style (e.g., small cap growth, small cap value, large cap growth, large cap value) and, then, ranks portfolios based on rate of return within the appropriate style universe.

Question 13

The Treynor Measure

Answer 13

The Treynor measure is very similar to the Sharpe ratio except that it uses beta (systematic risk) as the measure of risk. It shows the excess return (over the risk-free rate) earned per unit of systematic risk.

The Treynor measure is defined as:

T_A = (R_A - R_F)/ β_A

where:

• R_A = average account return
• R_F = average risk-free return
• β_A = average beta

Ideally, the Treynor measure should be calculated using the actual beta for the portfolio over the measurement period. Since beta is subject to change due to varying covariance with the market, using the premeasurement period beta may not yield reliable results. The beta for the measurement period is estimated by regressing the portfolio’s returns against the market returns.

For a well-diversified portfolio, the difference in risk measurement between the Sharpe ratio and the Treynor measure becomes irrelevant as the total risk and systematic risk will be very close. For a less than well-diversified portfolio, however, the difference in rankings based on the two measures is likely due to the amount of diversification in the portfolio. Used along with the Treynor measure, the Sharpe ratio provides additional information about the degree of diversification in a portfolio.

Sharpe vs. Treynor. If a portfolio was not well-diversified over the measurement period, it may be ranked relatively higher using Treynor than using Sharpe because Treynor considers only the beta (i.e., systematic risk) of the portfolio over the period. When the Sharpe ratio is calculated for the portfolio, the excess total risk (standard deviation) due to diversifiable risk will cause rankings to be lower. Although we do not get an absolute measure of the lack of diversification, the change in the rankings shows the presence of unsystematic risk, and the greater the difference in rankings, the less diversified the portfolio.

Question 14

Jensens Alpha

Answer 14

Question 15

Information Ratio

Answer 15

Length of the period, expressed in years, during which we observe the return IR with the set confidence level:

T= (t_stat/IR)²

There are (from the FRM perspective) two valid ways to define information ratio: active or residual (aka, alpha) based.

• We can use an active return as the numerator, but then the denominator should be “active risk;” i.e., the standard deviation of the active return.
• If we want to use the more sophisticated IR, we can use residual return (aka, alpha = regression intercept) in the numerator and residual risk in the denominator (i.e., either standard deviation of the alpha or, more commonly, standard error of the regression).

Question 16

M-Squared (M²) Measure

Answer 16

The M² measure compares the return earned on the managed portfolio against the market return, after adjusting for differences in standard deviations between the two portfolios.

There are no squared terms in the M-squared calculation. The term “M-squared” merely refers to the last names of its originators (Leah and Franco Modigliani).

The M² measure can be illustrated with a graph comparing the capital market line for the market index and the capital allocation line for managed Portfolio P. In Figure 2, notice that Portfolio P has a higher standard deviation than the market index. But, we can easily create a Portfolio P ’ that has standard deviation equal to the market standard deviation by investing appropriate percentages in both the risk-free asset and Portfolio P. The difference in return between Portfolio P’ and the market portfolio, equals the M² measure for Portfolio P.

Unfortunately, a consistent definition of M² does not exist. Sometimes M² is defined as equal to the return on the risk-adjusted Portfolio P’ rather than equal to the difference in returns between P ’ and M. However, portfolio rankings based on the return on P’ or on the difference in returns between P ’ and M will be identical. Therefore, both definitions provide identical portfolio performance rankings.

M² will produce the same conclusions as the Sharpe ratio. As stated earlier, Jensen’s alpha will produce the same conclusions as the Treynor measure. However, M² and Sharpe may not give the same conclusion as Jensens alpha and Treynor. A discrepancy could occur if the manager takes on a large proportion of unsystematic risk relative to systematic risk. This would lower the Sharpe ratio but leave the Treynor measure unaffected.

Question 17

Determine the statistical significance of a performance measure using standard error and the t-statistic

Answer 17

Question 18

Explain the difficulties in measuring the performance of hedge funds

Answer 18

The hedge fund is designed to provide positive alpha with zero beta to the investors overall composite portfolio. The hedge fund creates portable alpha in the sense that the alpha does not depend on the performance of the broad market and can be ported to any existing portfolio. Because the long-short fund is market-neutral, the alpha may be generated outside the investor’s desired asset class mix.

Unfortunately, hedge fund performance evaluation is complicated because:

• Hedge fund risk is not constant over time (nonlinear risk).
• Hedge fund holdings are often illiquid (data smoothing).
• Hedge fund sensitivity with traditional markets increases in times of a market crisis and decreases in times of market strength.

The latter problem necessitates the use of estimated prices for hedge fund holdings. The values of the hedge funds, therefore, are not transactions-based. The estimation process unduly smoothes the hedge fund “values,” inducing serial correlation into any statistical examination of the data.

Question 19

Explain how changes in portfolio risk levels can affect the use of the Sharpe ratio to measure performance

Answer 19

The Sharpe ratio is useful when evaluating the portfolio performance of a passive investment strategy, where risk and return characteristics are relatively constant over time. However, the application of the Sharpe ratio is challenged when assessing the performance of active investment strategies, where risk and return characteristics are more dynamic. Changes in volatility will likely bias the Sharpe ratio, and produce incorrect conclusions when comparing portfolio performance to a benchmark or index.

Question 20

Describe techniques to measure the market timing ability of fund managers with a regression and with a call option model, and compute return due to market timing

Answer 20

The returns to the calls plus bills portfolio are identical to the 100% perfect foresight returns. Therefore, the value or appropriate fee for perfect foresight should equal the price of the call option on the market index.

Question 21

Describe style analysis.
Describe and apply performance attribution procedures, including the asset allocation decision, sector and security selection decision, and the aggregate contribution.

Answer 21

The steps for Sharpe’s style analysis are as follows:

1. Run a regression of portfolio returns against an exhaustive and mutually exclusive set of asset class indices:

R_P = b_P1R_B1 + b_P2R_B2 + …+ b_PnR_Bn + e_P

where:

• Rp = return on the managed portfolio
• R_Bj = return on passive benchmark asset class n
• b_Pj = sensitivity or exposure of Portfolio P return to passive asset class n return
• e_P = random error term

2. Conduct a performance attribution (return attributable to asset allocation and to selection):

• The percent of the performance attributable to asset allocation = R² (the coefficient of determination).
• The percent of the performance attributable to selection = 1 — R².

The asset allocation attribution equals the difference in returns attributable to active asset allocation decisions of the portfolio manager:

[b₁R_B1 + b₂R_B2 + …+ b_nR_Bn] - R_B

Notice if the slopes (estimated allocations) for the managed portfolio equal those within the benchmark (passive asset allocation), then the asset allocation attribution will be zero.

The selection attribution equals the difference in returns attributable to superior individual security selection (correct selection of mispriced securities) and sector allocation (correct over and underweighting of sectors within asset classes):

R_P - [b₁R_B1 + b₂R_B2 + …+ b_nR_Bn]

Notice if the manager has no superior selection ability, then portfolio returns earned within each asset class will equal the benchmark asset class returns: R_Pj = R_Bj, and the selection attribution will equal zero. Also, notice that the sum of the two attribution components (asset allocation plus selection) equals the total excess return performance: R_P — R_B.

3. Uncover the investment style of the portfolio manager: the regression slopes are used to infer the investment style of the manager.

Question 22

Describe the characteristics of hedge funds and the hedge fund industry, and compare hedge funds with mutual funds

Answer 22

• There are important distinctions between hedge funds and mutual funds. Hedge funds are private, much less regulated investment vehicles, not available to the general public. On the other hand, mutual funds are more structured and regulated. Hedge funds are highly leveraged, and managers obtain profits from both long and short positions. Hedge fund managers tend to take large bets based on perceived relative price discrepancies of assets.
• Privacy is a hallmark of hedge funds. There is little transparency in the hedge fund industry because managers do not want their methods copied. A hedge fund charges a fixed management fee plus a healthy share of new profits from the fund, generally around 10- 20% .

Question 23

Explain biases that are commonly found in databases of hedge funds

Answer 23

• There is selection bias, also known as self-reporting bias, contained in hedge fund databases.
• There is evidence that suggests that selection bias in large hedge fund databases is actually small.

Question 24

Explain the relationship between risk and alpha in hedge funds

Answer 24

• Alpha is a risk-adjusted measure of return often used to assess the performance of active managers. It is the return in excess of the compensation for risk. It is important to identify how much of a strategy’s return results from risk (i.e., beta) and how much results from active management (i.e., alpha). This is known as distinguishing alpha and beta.
• A hedge fund may attempt to independently manage alpha and beta. The firm may manage beta exposure while separately managing the portfolio’s alpha. This is known as separating alpha and beta. Managers can use investment tools to pursue alpha while sustaining a target beta for the portfolio. Managers typically seek to limit beta while trying to optimize alpha. Derivatives are often used to minimize or eliminate undesired systematic risk.

Question 25

Managed Futures and Global Macro hedge fund

Answer 25

• Managed futures funds focus on investments in bond, equity, commodity futures, and currency markets around the world. Systematic trading programs are used which rely on historical pricing data and market trends. A high degree of leverage is employed because futures contracts are used. With managed futures, there is no net long or net short bias.
• Many managed futures funds are market timing funds, which switch between stocks and Treasuries. When both short and long positions are considered, the payoff function of this strategy is similar to a lookback straddle, which is a combination of a lookback call option and a lookback put option. The lookback call option gives the owner the right to purchase the underlying instrument at the lower price during the call option’s life, while the lookback put option gives the owner the right to sell the underlying instrument at the highest price during the put option’s life.
• Global macro fund managers make large bets on directional movements in interest rates, exchange rates, commodities, and stock indices. They are dynamic asset allocators, betting on various risk factors over time.
• Both managed futures and global macro funds have trendfollowing behavior (i.e., directional styles). Global macro funds do better during extreme moves in the currency markets. Both of these strategies are essentially asset allocation strategies, since the managers take opportunistic bets in different markets. They also both have a low return correlation to equities.

Question 26

Merger/Risk Arbitrage and Distressed Securities hedge funds

Answer 26

• Merger (or risk) arbitrage strategies try to capture spreads in merger/acquisition transactions involving public companies, following public announcement of a transaction. The primary risk is deal risk, or the risk that the deal will fail to close.
• Distressed hedge funds is another event-driven hedge fund style. This strategy invests across the capital structure of firms that are under financial or operational distress, or are in the middle of bankruptcy. The strategy tends to have a long bias. With this strategy, hedge fund managers try to profit from an issuer’s ability to improve its operation, or come out of a bankruptcy successfully.

Question 27

Fixed Income Arbitrage funds

Answer 27

Fixed income arbitrage funds attempt to obtain profits by exploiting inefficiencies and price anomalies between related fixed income securities. The fund managers try to limit volatility by hedging exposure to interest rate risk.

The sectors traded under fixed income arbitrage include:

• Credit yield curve relative value trading of swaps, government securities, and futures.
• Volatility trading using options.
• Mortgage-backed securities arbitrage.

A swap spread trade is a bet that the fixed side of the spread will stay higher than the floating side of the spread, and stay in a reasonable range according to historical trends. With yield-curve spread trades, the hope is that bond prices will deviate from the overall yield curve only in the short term, and will revert to normal spreads over time. Mortgage spread trades are bets on prepayment rates, while fixed income volatility trades are bets that the implied volatility of interest rate caps have a tendency to be higher than the realized volatility of, for example, a Eurodollar futures contract. Capital structure or credit arbitrage​ trades try to capitalize on mispricing among different types of securities (e.g., equity and debt).

Question 28

Convertible Arbitrage funds

Answer 28

• Convertible arbitrage funds attempt to profit from the purchase of convertible securities and the shorting of corresponding stock, taking advantage of a perceived pricing error made in the security’s conversion factor. The number of shares shorted is based on a delta neutral or market neutral ratio. The plan is for the combined position to be insensitive to underlying stock price fluctuations under normal market conditions.
• The return to convertible arbitrage hedge funds comes from the liquidity premium paid by issuers of convertible bonds to hedge fund managers, for holding convertible bonds and managing the inherent risk by hedging the equity part of the bonds.

Question 29

Long/Short Equity funds

Answer 29

• Long/short equity funds take both long and short positions in the equity markets, diversifying or hedging across sectors, regions, or market capitalizations. Examples are shifts from value to growth, small- to mid-cap stocks, and net long to net short. Trades in equity futures and options can also take place.
• Thirty to forty percent of hedge funds are long/short. Long/short managers are stock pickers with varying opinions and abilities, so performance tends to be very idiosyncratic. Underpriced or under-researched stocks are favored, as are small stocks, on the long side. On the short side, low liquidity makes small stocks and foreign stocks less attractive. Long/short equity funds have directional exposure to the overall market and also have exposure to long small-cap/short large-cap positions.

Question 30

Dedicated Short Bias, Emerging Markets, Equity Market Neutral funds

Answer 30

Dedicated Short Bias

• Funds with a dedicated short bias tend to take net short positions in equities. Sometimes the short position strategy is implemented by selling forward. To manage risk, managers take offsetting long positions and stop-loss positions. The returns are negatively correlated with equities.

Emerging Markets

• Emerging market funds invest in currencies, debt, equities, and other instruments in countries with emerging or developing markets. These markets are usually identified in terms of gross national product (GNP) per capita. China, India, Latin America, Southeast Asia, parts of Eastern Europe, and parts of Africa are examples of emerging markets. These funds have a long bias because it is more difficult to short securities in emerging markets.

Equity Market Neutral funds

• When reviewing equity market neutral hedge fund strategies, research shows that there is not one common component (or risk factor) in their returns. Different funds utilize different trading strategies, but they all have a similar goal of trying to achieve zero beta(s) against a broad set of equity indices.

Question 31

Describe the historical portfolio construction and performance trend of hedge funds compared to equity indices

Answer 31

Hedge fund portfolios had no significant exposure to stocks and bonds.

Question 32

Describe market events that resulted in a convergence of risk factors for different hedge fund strategies, and explain the impact of such a convergence on portfolio diversification strategies

Answer 32

When there is a market-wide funding crisis, it is difficult to mitigate risk by simply spreading capital among different hedge fund strategies. There is significant credit-driven tail risk in a hedge fund portfolio. The use of managed futures may be a partial solution— it has been a strategy with a convex performance profile relative to other hedge fund strategies. Hedge fund investors need to consider portfolio risks associated with dramatic market events.

Question 33

Describe the problem of risk sharing asymmetry between principals and agents in the hedge fund industry

Answer 33

• In the hedge fund industry, risk sharing asymmetry between the principal (investor) and the agent (fund manager) is a concern due to variable compensation schemes.
• The problem occurs when the incentive fee that a hedge fund manager is entitled to, typically 15—20% of new profits [profits above a high water mark (HWM)], encourages a fund manager to take outsized risks. This tends to increase the future loss-carried-forward if and when these bets fail. If the fund fails, the same fund manager can start up a new hedge fund.

Question 34

Explain the impact of institutional investors on the hedge fund industry and assess reasons for the growing concentration of assets under management (AUM) in the industry.

Answer 34

With the increase of institutional investment came greater demands on hedge fund management for operational integrity and governance. Some institutional investors were seeking absolute performance, while others were seeking alternative sources of return beyond equities. There is some concern that there is no identifiable alpha associated with hedge fund investing, so it is increasingly important that hedge fund managers differentiate themselves from their peers.