By Dimitris N. Chorafas (auth.)
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Extra resources for Alternative Investments and the Mismanagement of Risk
Merrill Lynch has been a vendor of alternative investments for many years, promoting several funds and funds of funds. However, on 1 July 2002, this investment bank found the courage to write the following in its US Strategy Update: Cash has now outperformed the S&P 500 for the time period spanning the last 55 months (December 1997 to July 2002). 16 Add to the S&P reference made by Merrill Lynch all hedge funds and any other alternative investment vehicle, and you have a perfect quotation summarising in a nutshell the message Chapter 1 brings to the reader.
To begin with, one way to appreciate how much risk the end-investor assumes with funds of funds and special alternative investment vehicles (SAIVs) is to focus on the effects of volatility and liquidity. Market illiquidity and market volatility correlate among themselves, and with highly leveraged trading. Are Alternative Investments Inherently Risky? 31 Illiquidity and volatility magnify the risks A great deal of alternative investments positions, and trading associated with them, involve instruments which are not only inherently geared but also volatile and materially affected by unpredictable factors.
That is the gamble of private placements (see Chapter 1). Hedge funds specialising in small caps and in private equity would surely appreciate the reviewer’s message in his third bullet. But, I take exception to the reviewer’s second statement which I consider to be a lie. Geared instruments have a high sensitivity to the liquidity of markets. Hedge funds try to counteract this through diversification, but diversification has its own risks as we have just seen. Market liquidity and illiquidity are also characterised by cycles.
Alternative Investments and the Mismanagement of Risk by Dimitris N. Chorafas (auth.)