By Dimitris N. Chorafas (auth.)
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Extra info for Alternative Investments and the Mismanagement of Risk
In late October 2001, I met with Tim Tacchi and Henry Bedford, co-chief executives of TT International, a Londonbased hedge fund. ‘One of the most important decisions in investment is whether you are pessimistic or bullish about the market’s prospects,’ said Tim Tacchi. Chances are the net asset value (NAV) allocation in equities will be around 20 per cent if the fund manager is pessimistic, and 80 per cent if he is bullish. Among the factors which enter into this evaluation are: ● ● ● ● the fund manager’s own appreciation of market sentiment; macroeconomic criteria; trends in market behaviour; and the securities themselves.
In spite of a manager’s strategy of going long and going short, alternative investments will by no means be always profitable during downward cycles in stock and bond prices. Their performance may or may not be similar to that of the general financial markets. ● ● During certain periods, the results they obtain might be correlated to more traditional portfolio holdings, providing little if any diversification. Alternatively, geared instruments can easily lose more in adverse markets, and gain less in favourable markets, than the stock and bond assets underlying the derivatives.
One experiment I undertook between January 2000 and February 2002 was to speak to many experts: analysts, quants, investment advisors, asset managers, hedge fund executives. When I ask the question of market direction, I made a point to write down their answer – and then check it in the light of subsequent developments. The hit rate has been 30 per cent. Even 50 per cent failures in prediction can be an unmitigated disaster with high gearing, and many of these people were dealing with leveraged investments.