Last year was a rough one for hedge funds, with disappointing returns, and numerous high profile blowups. How can you protect yourself against the bad eggs? Blogger Richard Bookstaber, who worked at Bridgewater Associates, ran the Quantitative Equity Fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management, has a few suggestions for what to avoid. He calls them the “seven habits of highly suspicious hedge funds.”
First, be wary of “no independent risk reporting.” Bookstaber says, “trust but verify.” The risk numbers must come from a third party that gets the fund's positions and does the analysis. Secondly, any sign of “a change for the worse in the critical risk numbers,” is worth further investigation. Increased use of derivatives is another, especially if the fund only recently decided to start using derivatives and swaps. Bookstaber says to also look out for a high level of secrecy and a growth in headcount or big changes in lifestyle at the fund. Lastly, the obvious — a decline in assets under management and lackluster performance in recent years are good indications that the fund is primed to ratchet up risk.