Hedge Fund Risk Limits Explained
Could someone who has experience working at a L/S fund clearly explain how hedge funds observe the following risk limits:
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What is the difference between market-neutral, beta-neutral, and having some X% of "net exposure"?
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What is the difference between being factor-neutral and factor-aware?
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Why do the large MMs target only a few % points of alpha with "highly levered money"?
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What does being paid on drawdown mean?
Would greatly appreciate any insight anyone can share.
Bump
quant for last 2 years, I will try to answer whatever I know:
1)Market neutral ~ you have equal amount of $ in both long and short position . Beta neutral mean your strategies have close to 0 correlation to SPX return measured over a lookback of last 52 weeks or so. X% net exposure probably means not completely market neutral ,can be more $ in long than short.
2)Factor neutral(dot product is close to 0) means your strategy is neutralized to various factors like value, momentum etc ,so this means you are reducing your exposure to factor returns. Not exactly sure about factor aware ,i would think it means having significant exposure to a particular factor but you also have algorithm to rotate efficiently over time to different factors.
3)the goal is to produce risk adjust returns. If you are able to produce even low single digit returns like 2-3% but have strategies that have high liquidity(alpha still exist even after trading at large size, don't have much market impact) .Then you can make a lot of money.
4)I dont know what this means.
Thanks GoodGuy.
For #3, does the high liquidity assumption mean the size of your position is significant in both the Long and Short side? So assuming $25M in the Long and $25M in the Short position, would the 3% target imply $750,000 return? It seems very low for the amount of capital you are risking. Or does this assume you are funding the longs with your shorts so you basically make $750k on zero cost?
Individual strategies can have varying returns ,the 3 % is at a fund level ,which is net of money gained - money lost ,most strategies lose money . When your are talking about 3% at fund level this is thinking that you are running your book at 2bn+, 5bn+ dollars. same strategy which earns 10% on 100 million dollars ,will not earn 10% at 500 million dollar.
Thanks again GoodGuy. One more quick question: What is the underlying reason for liquidity dictating how much you can scale alpha? With respect to #3 on your first reply and since you mentioned: "same strategy which earns 10% on 100 million dollars ,will not earn 10% at 500 million dollar."
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