The primary responsibility of the hedge fund risk manager is to identify and quantify the sources of risk. The most common types of risk in the HF industry (and the duties of risk managers for each type) are:
Liquidity Risk (The Ability of the Firm to Meet its Needs for Cash)
In this role, risk managers monitor and manage liquidity to ensure that the hedge fund has cash when needed. They also review credit and lending agreements made with lenders and investors in order to ensure that liquidity will be maintained in the event of triggering events or extreme market conditions. Finally, they conduct regular liquidity stress scenario analyses on the hedge fund to ensure that cash will be available when needed.
Market Risk (The Financial Risk Created by Changes in the Market Price of Investments in the Hedge Fund)
To reduce market risk, hedge fund risk managers identify the size and direction of the firm’s exposure to major market risk factors (e.g., commodities prices, foreign exchange rates, interest rates). They also conduct scenario analyses and stress tests on the firm’s investment portfolio, as well as on its investment strategies, asset group, and other criteria.
Operational Risk (The Firm’s Internal Processes, Employees, and Systems)
In this role, risk managers ensure that a chief operating officer is in place to manage operational areas outside the realm of investment management; make sure that the hedge fund manager has created strong internal controls to reduce the risk of losses tied to operational risk; and ensure that operational risks related to Information Technology, disaster recovery planning, and business continuity are identified and addressed.
Legal and Compliance Risk (Issues Related to Regulatory Compliance)
To reduce legal and compliance risk, hedge fund risk managers work closely with the firm’s chief compliance officer to ensure that regular compliance filings are made to the Securities & Exchange Commission and other regulatory bodies; identify compliance issues that would create the risk of regulatory non-compliance; and review legal contracts and other documents to assess potential risk factors.