Hedge Fund Investing: Identification of Potential 'Blow-Up' Managers

Abstract:     
Increases in market volatility and sharp changes in liquidity have resulted in a number of hedge funds across strategies experiencing larger drawdowns. Return analysis has frequently been used to determine risk and liquidity profile of hedge funds. This paper centers on identifiable characteristics of hedge fund culture, business model, and senior management psychological profile that conduce to excessive risk and “blow-up” magnitude losses. It is contended that the probability of unwarranted tail risk increases significantly with flaws in investment process, portfolio construction, investment style, risk and liquidity management, lack of experience, and organizational structure; all of which are identifiable. Due diligence can help identify many dangerously loss-prone fund managers ex-ante.

Number of Pages in PDF File: 12

Keywords: Hedge Fund, Drawdown, Due Dilegence, Investing

working papers series