Yoichi Umeki was born and raised in Japan, has studied in Canada, and has worked in New York, Toronto, London and Tokyo. His professional career covers more than 15 years in the derivatives industry, including trading, structuring and sales of FI, FX, Commodity products and Derivatives. Since 1997, he had been the risk manager for Lehman Brothers in Tokyo with market risk management responsibility in all of Asian Fixed Income products. His risk management experiences include analysis of counter party credit risks and dealing with the regulatory issues globally. Recent consulting work includes setting up the risk management
infrastructure for a global commodity and energy trading group. He has been a very active SC member of GARP Japan and Tokyo Risk Managers Association. Since joining Asia-Pacific Consulting as a director, he has focused on hedge fund risk management. Asia-Pacific Consulting provides experienced & independent opinions, specializing in the alternative investments area. Its main focus is on due diligence of hedge funds in the Asia Pacific zone with a special emphasis on Japan.

a) What are the major initial risks that should be considered by a start-up manager?

For a start up manager, just like any other business, the main focus should be to get the business going. From a risk management point of view, it is a case of business risks. Until the business comes to a stable stage, the fund may have to deal with extra business risks that a matured fund may have already overcome. Detailed due diligence work and careful implementation of all the necessary risk infrastructure will lead to a successful launch.

b) What kind of risk management systems should a hedge fund manager try to have in place from the beginning?

The number one job for risk management is to protect the fund from worst-case scenarios. In other words, while day-to-day risk management enhances the efficiency of risk return ratios, it should also protect the fund from forced closure. Therefore, you need to have a system that can handle and monitor respectable scenarios that may have a significant negative value move on the fund.

c) How would the risk profile of a hedge fund change with size?

Hedge fund business is typically done based on a specific strategy and possible high degree of concentrated risks. Therefore, it is very important to apply “micro-risk management”. As the size of the fund grows, such concentration degree may fall and diversification in strategies may take place. That will lead to the need of “macro-risk management”, which typically focus on integration of risks and top-down approach in risk management.

d) What risk management options are available for a hedge fund manager?

There are several roles that a risk manager can play. This is not the case of optional choices from varieties of risk management techniques, such as VaR, sensitivities, concentration, stress testing and so on. All detailed risk management techniques have value in its use and complement each other. Important point here is that you have to know which to use for what and when.

It is kind of like carpentry tools. To cut the board what do you use? If you can afford to pay for power tools like a circular saw, it will be much more efficient than using a hand saw. However, if you do not know what you are doing you may simply use a sledgehammer to break the wood into two pieces but they no longer are useful. While VaR kind of reports are used to monitor day-today risk moves on a aggregated basis, stress reports can assist you better to deal with the extraordinary situation that may only happen once a year or even less.

e) I hear risk management can cost a lot of money. Why is it so and is there any way around this?

Cost of risk management can be considered high if you only use it for report generation. However, as mentioned above, it can add considerable value to the business and easily cover its cost. And if it can really protect the fund from forced closure then the cost of not having it is too expensive. Having said that, many sell-side companies do spend millions of dollars every year for a known vendor system. There are ways around this and there are vendor systems that can be quite cost effective. These are usually systems designed for smaller user. There are also risk management systems specifically designed for the hedge fund industry. Reech Capital, for example, has an ASP style system to reduce the cost for the user. It has strong capability around a higher degree of option products, i.e. exotics and non-traditional products. It also deals with the decomposition of the portfolio risks that the user can benefit from pinpointing risk attributions.

f) What are the unique risks in the Hedge Fund business if there are any?

As mentioned earlier the hedge fund business tends to be highly concentrated in certain products, ideas, and markets. Therefore, it has more liquidity risks, concentration risks, and possibly regulatory issues, a point in case being the currency wars between central bankers and hedge fund managers.

g) What do you think of the state of risk management in HF industry compared with the sell-side?

There is no doubt that sell-side risk management has gone into a mature stage of development while hedge fund industry has lot more to catch up with. Risk management can certainly enhance the efficiency of the hedge fund business. However, you really have to understand that the definition of risk management is not the same between the two. Sell-side risk management is based on the two concepts; regulation and integration, issues hedge funds tend not to have. The hedge fund industry is catching up rapidly and the example I gave with certain risk systems like Reech is a very advanced system that the sell-side has known about but has been unable to implement. This is more to do with the differences in the decision making process. Hedge fund managers tend to better understand the ‘true’ value of risk management. When we can provide added value, they jump on it. So my guess is hedge fund risk management will catch up with the sell-side in no time at all and will exploit the value of risk management more comprehensively.

h) You mentioned some unique attributes of the Hedge Fund business earlier, would it make it harder to apply sell-side risk management techniques for it?

Yes and no. The difference can be illustrated by the definition of risk management. In a typical sell-side company risk management has to aggregate corporate wide risks and integrate them among different risk categories like market, credit, and operational risks. I call this “macro-risk management”. However, other businesses like principal investment, real estate and many of the alternative investments including hedge funds require due diligence work as the most important process in its risk management. It is not the work of aggregating and integrating. So I call it “micro-risk management”. Having said that, the risk management concept developed in sell-side can be applied to hedge fund industry without any problem.

i) Do you think hedge fund managers should employ in-house risk managers?

Yes. The hedge fund environment has been changing rapidly as the size and number of market participants grow in the industry. They have been forced to deal with more regulatory, technical and compliance issues. No fund managers want to deal with these issues and be distracted from trading. So there is need for a specialist to deal with such issues. Also, just like the example of vendor system, risk management can be tailor-made for the hedge fund industry, which probably means that the risk manager for the industry has to be more multi-task oriented and has to be ensured that they are adding value to the fund.

j) What do you think of the industry future in terms of risk management?

Yoichi Umeki

General Manager Risk Management, Asia-Pacific Consulting

Tel: +81-3-5733-3608 Email: yumeki@apaconsult.com

Web: http://www.apaconsult.com

The industry is changing fast in its business and environment. There are many ideas created in different parts of the financial world like sell-side risk management and independent dedicated risk management companies. Hedge funds can learn from them, take the best parts and enhance the use of risk management to suit their needs. The future of the hedge fund industry is inextricably linked to the development of risk management practices.

This entry was posted on Monday, October 20th, 2003 at 7:39 pm.

Yoichi Umeki was born and raised in Japan, has studied in Canada, and has worked in New York, Toronto, London and Tokyo. His professional career covers more than 15 years in the derivatives industry, including trading, structuring and sales of FI, FX, Commodity products and Derivatives. Since 1997, he had been the risk manager for Lehman Brothers in Tokyo with market risk management responsibility in all of Asian Fixed Income products. His risk management experiences include analysis of counter party credit risks and dealing with the regulatory issues globally. Recent consulting work includes setting up the risk management
infrastructure for a global commodity and energy trading group. He has been a very active SC member of GARP Japan and Tokyo Risk Managers Association. Since joining Asia-Pacific Consulting as a director, he has focused on hedge fund risk management. Asia-Pacific Consulting provides experienced & independent opinions, specializing in the alternative investments area. Its main focus is on due diligence of hedge funds in the Asia Pacific zone with a special emphasis on Japan.

a) What are the major initial risks that should be considered by a start-up manager?

For a start up manager, just like any other business, the main focus should be to get the business going. From a risk management point of view, it is a case of business risks. Until the business comes to a stable stage, the fund may have to deal with extra business risks that a matured fund may have already overcome. Detailed due diligence work and careful implementation of all the necessary risk infrastructure will lead to a successful launch.

b) What kind of risk management systems should a hedge fund manager try to have in place from the beginning?

The number one job for risk management is to protect the fund from worst-case scenarios. In other words, while day-to-day risk management enhances the efficiency of risk return ratios, it should also protect the fund from forced closure. Therefore, you need to have a system that can handle and monitor respectable scenarios that may have a significant negative value move on the fund.

c) How would the risk profile of a hedge fund change with size?

Hedge fund business is typically done based on a specific strategy and possible high degree of concentrated risks. Therefore, it is very important to apply “micro-risk management”. As the size of the fund grows, such concentration degree may fall and diversification in strategies may take place. That will lead to the need of “macro-risk management”, which typically focus on integration of risks and top-down approach in risk management.

d) What risk management options are available for a hedge fund manager?

There are several roles that a risk manager can play. This is not the case of optional choices from varieties of risk management techniques, such as VaR, sensitivities, concentration, stress testing and so on. All detailed risk management techniques have value in its use and complement each other. Important point here is that you have to know which to use for what and when.

It is kind of like carpentry tools. To cut the board what do you use? If you can afford to pay for power tools like a circular saw, it will be much more efficient than using a hand saw. However, if you do not know what you are doing you may simply use a sledgehammer to break the wood into two pieces but they no longer are useful. While VaR kind of reports are used to monitor day-today risk moves on a aggregated basis, stress reports can assist you better to deal with the extraordinary situation that may only happen once a year or even less.

e) I hear risk management can cost a lot of money. Why is it so and is there any way around this?

Cost of risk management can be considered high if you only use it for report generation. However, as mentioned above, it can add considerable value to the business and easily cover its cost. And if it can really protect the fund from forced closure then the cost of not having it is too expensive. Having said that, many sell-side companies do spend millions of dollars every year for a known vendor system. There are ways around this and there are vendor systems that can be quite cost effective. These are usually systems designed for smaller user. There are also risk management systems specifically designed for the hedge fund industry. Reech Capital, for example, has an ASP style system to reduce the cost for the user. It has strong capability around a higher degree of option products, i.e. exotics and non-traditional products. It also deals with the decomposition of the portfolio risks that the user can benefit from pinpointing risk attributions.

f) What are the unique risks in the Hedge Fund business if there are any?

As mentioned earlier the hedge fund business tends to be highly concentrated in certain products, ideas, and markets. Therefore, it has more liquidity risks, concentration risks, and possibly regulatory issues, a point in case being the currency wars between central bankers and hedge fund managers.

g) What do you think of the state of risk management in HF industry compared with the sell-side?

There is no doubt that sell-side risk management has gone into a mature stage of development while hedge fund industry has lot more to catch up with. Risk management can certainly enhance the efficiency of the hedge fund business. However, you really have to understand that the definition of risk management is not the same between the two. Sell-side risk management is based on the two concepts; regulation and integration, issues hedge funds tend not to have. The hedge fund industry is catching up rapidly and the example I gave with certain risk systems like Reech is a very advanced system that the sell-side has known about but has been unable to implement. This is more to do with the differences in the decision making process. Hedge fund managers tend to better understand the ‘true’ value of risk management. When we can provide added value, they jump on it. So my guess is hedge fund risk management will catch up with the sell-side in no time at all and will exploit the value of risk management more comprehensively.

h) You mentioned some unique attributes of the Hedge Fund business earlier, would it make it harder to apply sell-side risk management techniques for it?

Yes and no. The difference can be illustrated by the definition of risk management. In a typical sell-side company risk management has to aggregate corporate wide risks and integrate them among different risk categories like market, credit, and operational risks. I call this “macro-risk management”. However, other businesses like principal investment, real estate and many of the alternative investments including hedge funds require due diligence work as the most important process in its risk management. It is not the work of aggregating and integrating. So I call it “micro-risk management”. Having said that, the risk management concept developed in sell-side can be applied to hedge fund industry without any problem.

i) Do you think hedge fund managers should employ in-house risk managers?

Yes. The hedge fund environment has been changing rapidly as the size and number of market participants grow in the industry. They have been forced to deal with more regulatory, technical and compliance issues. No fund managers want to deal with these issues and be distracted from trading. So there is need for a specialist to deal with such issues. Also, just like the example of vendor system, risk management can be tailor-made for the hedge fund industry, which probably means that the risk manager for the industry has to be more multi-task oriented and has to be ensured that they are adding value to the fund.

j) What do you think of the industry future in terms of risk management?

Yoichi Umeki

General Manager Risk Management, Asia-Pacific Consulting

Tel: +81-3-5733-3608 Email: yumeki@apaconsult.com

Web: http://www.apaconsult.com

The industry is changing fast in its business and environment. There are many ideas created in different parts of the financial world like sell-side risk management and independent dedicated risk management companies. Hedge funds can learn from them, take the best parts and enhance the use of risk management to suit their needs. The future of the hedge fund industry is inextricably linked to the development of risk management practices.

This entry was posted on Monday, October 20th, 2003 at 7:39 pm.