With so many proprietary risk measurement systems in use and little demand from a largely high-net-worth client base, a common language of risk measurement didn't even exist in the industry until recently, said Ron Papanek, chief market strategist at RiskMetrics Group, New York, a risk systems provider.
"Investors are requiring their hedge fund managers to report risk in the same way, especially value at risk. Risk has become a language, rather than a proprietary tool," said Mr. Papanek.
The new commonality in risk measurement and communication among hedge funds, their service providers and investors is almost entirely driven by institutions, said risk consultant Brian Shapiro, president of CarbonBased Consulting LLC, New York.
Application technologies for measuring, monitoring and reporting hedge fund risk have exploded in number, Mr. Shapiro said. Carbon360, CarbonBased Consulting's research arm, recently analyzed 106 risk management and reporting systems, up from nine in 2001, when similar analysis was performed by another risk consultant, Capital Market Risk Advisors LLC, New York.
"Institutional investors want more transparency, which includes independent valuations and position-level information. Hedge fund managers interested in selling themselves to institutional investors are using the systems to make themselves more attractive," Mr. Shapiro said.
Since many hedge funds are reluctant, for competitive reasons, to provide their holdings information in an identifiable manner, many institutional hedge fund investors, including hedge funds of funds, are willing to accept risk reporting through an independent third party. Such firms — including RiskMetrics Group and Bear Measurisk LLC, both in New York — accept monthly holdings information from hedge fund managers and run a series of analytics on the data, which is aggregated and provided to the investor in report form.
Bear Measurisk, for example, provides a variety of risk measurement services, including stress testing, value at risk, exposure reporting, sensitivity coverage and independent valuation. "We act as an intermediary between the hedge fund and investors, aggregating risk across portfolios. We end up providing risk transparency, not holdings transparency, which is what end users — primarily hedge funds of funds and direct hedge fund investors — want," said Andrew Lapkin, president. But the lure of institutional assets has not convinced many hedge fund managers to provide more data, even to a neutral third-party provider that guarantees confidentiality.
However, demand from hedge fund-of-funds managers and institutional investors is exerting pressure on hedge funds, and the pace of cooperation is increasing. Mr. Lapkin said executives at Bear Measurisk have seen a four-fold increase in the number of managers providing transparency in the last year, and he excepts that the number of cooperative funds will double within the next 12 months