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In his speech at GAIM entitled “How can we anticipate which market scenarios can hurt hedge fund performance?”, Dr Raphael Douady, Research Director of Riskdata discussed the lessons of October’s significant losses.

Riskdata’s risk profile analysis of aggregated HF & FoF indices, using data up to September 2005, shows a significant exposure to emerging market Asia, small caps, energy and high yield. If one were to use this risk profile to extrapolate what would be the behaviour of these aggregated indices from the 1st to the 20th October, one would find predicted losses of 0.9%, very close to the actual loss. This “out of the sample” estimate is strong evidence supporting the view that interprets ‘Red October’ as a direct consequence of a significant concentration of exposure on these markets, combined with the fact that a large number of funds liquidated their positions during the month to secure their cumulated returns.

Dr Douady said “The key question for FOHFs is whether October’s performance will lead to the loss of institutional money. The logical answer is that if the performance was a surprise, institutional money may be at risk. But we don’t think October should have been a complete surprise.

“If the portfolio is simply a black box from the perspective of institutional investors, then they can only form the conclusion that a 1.5% monthly loss is due to bad manager selection. If, on the other hand, it can be explained by market exposure, which the FOHF m......................

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