Flexibility is the key factor. Investors hire talented portfolio managers with the objective that they deploy their alpha skills. If a manager loses the capacity to adapt his portfolio to difficult markets, he can no longer exercise his skills. In other words, skill alone does not guarantee performance. Success also requires an appropriate balancesheet structure within which a manager can remain flexible and avoid the risk of becoming a toy in the hands of the market, his investors and his prime brokers. Every manager’s motto should be: “Play the game, never become the game”. The systematic approach to balance-sheet structure analysis that we have introduced in this article serves two purposes: first, it makes a contribution to closing the gap with regard to the management of extreme risks; and second, it allows those managing portfolios of hedge funds to assess the risk of a manager losing flexibility and being tossed about at the whim of the market.
By Dr. Nicholas Verwilghen, who is a partner and Head of Quantitative Research and Dr. Didier Michoud, who is Senior Quantitative Analyst of the EIM Group in Nyon :
http://www.eimgroup.com/jahia/webdav/site/eim/users/eimadmin/public/Systematic%20Approach%20to%20Measuring%20Hedge%20Funds%20Implied%20Credit%20Risk.pdf
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