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GameStop is Forcing Hedge Funds to Manage Risk More Effectively

GameStop is Forcing Hedge Funds to Manage Risk More Effectively

How the GameStop Crisis Red Flagged Improving Workflow Management at Hedge Funds

The Reddit, GameStop short squeeze crisis increased client anxiety and uncovered risks stemming from poor transparency and workflow within asset management firms including hedge funds, private equity funds, and alternative asset management firms. We know that inherently, asset management firms leverage investing strategies that often carry higher investment risk so that they can generate alpha or returns higher than their benchmark; the S&P 500 index for example.

Hedge funds and private equity funds were created to operate as a better investment vehicle than a mutual fund because they could use alternative investment strategies, shorting stocks, for example, and because they were not bound by a stringent set of investing rules in terms of time or industry.

How the GameStop Crisis Red Flagged Improving Workflow Management at Hedge Funds
Figure – Gamestop’s Business Model and Covid Made the Company a Prime Target for Short Sellers

However, when the investment environment becomes as unstable as it did with GameStop, AMC, Bed, Bath & Beyond, and several of the other Reddit targets, the investment risk of asset management firms subsequently increased in volatility. Thus, now, the hedge fund clients that we serve strongly suggest that they need to focus on their investment strategies and not get side-tracked or lose transparency in their investment strategies because of workflow, process matters, and other operational issues that may not have previously presented as great a concern.

Front, middle, and back-office workflow and operation need to be visible, verified, tracked and managed to completion within a single, simple solution.

Our clients have suggested that adding as much of their workflow processes into a single, flexible platform should provide visibility, critical data, insights, and proactive notifications to the entire staff within the progression of a process or transaction. Front, middle, and back-office workflow and operation need to be visible, verified, tracked and managed to completion within a single, simple solution. From research to trading, operational risk and compliance, customer service and marketing and internal and external reporting requirements should all be managed in concert.

 

Will Improving Fund Operations Reduce GameStop-like Risk Events?

Let’s take a step back and re-visit the impact of the GameStop, Reddit, Hedge Fund news story to illustrate our “increased risk” point. Over the past several weeks, an unusual battle has been waged between retail investors and Wall Street’s corporate investment firms over the past week. The focus of the battle is struggling video game chain GameStop as well as several other companies and their stocks which we discussed in a previous blog post.

GameStock’s stock surged from about $19 to $483 in just three weeks — a gain of more than 2,400%. The gain was shocking to most Wall Street veterans because GameStop is a physical retailer selling physical games and consoles in an industry going through a massive digital transformation in which the vast majority of games are downloaded or streamed. A fairly appropriate analogy made by many retail analysts was that GameStop had become the “Blockbuster Video” of the gaming industry.

As we suggested in our previous blog post, despite its struggling business model, the 5.7 million members of a Reddit group called r/wallstreetbets were buying GameStop shares in an effort to force short-sellers to capitulate driving the price even higher.

Figure – Actual Ryan Eyes Investment Exposure Dashboard

Several hedge funds lost upwards of 53% in a single 30-day period on GameStop and other investments. And a variety of other hedge funds lost 20% plus in just a few trading days either from short sale losses or investments in the trading platform Robinhood which has been the app of choice for many Reddit investors. The bottom line is that risk should be managed in a way that long-short hedge funds do not lose that much money in such a short time on a single bet or investment.

 

 

Can We Really Tie Fund Operations to Fund Risk?

The short answer is absolutely. Fund managers or risk managers within a fund are responsible for monitoring and managing a dozen or more risk metrics including trading limits, stress testing, liquidity analysis, backtesting, understanding leverage are concentration risk are just a few. Further, each one of these metrics changes each trading day as asset prices move and the firm adds, reduces, or eliminates positions.

Imagine having to check your brakes, brake fluid, gasoline and oil levels, tire pressure, and the variety of other issues on a car that could go wrong on even a short drive. The good news is over the past couple of decades the car industry added red and yellow lights, noises, and other alarms to a dashboard so that you could focus on operating the vehicle rather than focusing on the myriad of issues that could go wrong with the car. Thus, with vehicle operation clearly in focus and service issues being somewhat managed and automated by the car’s computer system the overall risk of being stranded or having an accident due to faulty brakes is greatly reduced.

I hope that analogy made some sense, but to put a bow on the point, the Hedge Fund Journal suggests “our survey queried respondents on their use of 10 risk metrics for both position risk and portfolio risk, as well as risk governance. The results show considerable variation: some funds appear to have in place a risk management structure that is appropriate for their strategies and investments, but other funds may be falling short. The sophistication of their risk management policies and procedures may not be keeping pace with the complexities of their strategies and investments, raising the concern that they are exposing themselves and their investors to risks that they do not fully understand.”

 

 

How Can Ryan Eyes Software Reduce Hedge Fund Investment Risk?

Fund managers leverage a variety of calculations to measure the risk of their investments and portfolio. The benefit of the calculations is that they provide insight into how their investments and portfolios will perform given a variety of scenarios. The problem managers have is conducting these complex calculations consistently as they evaluate investments. Ryan Eyes software handles the calculations instantly and presents the resulting analysis in a clean, dashboard format. Ryan Eyes provides the following calculations:

  • Sharpe and Sortino Ratios Drawdown
  • Monte Carlo Analysis
  • Shock Analysis
  • Risk Triggers on the Greek values which include theta, vega, delta, and
  • gamma
  • Portfolio Optimization
  • VaR
  • Concentration Limits
  • Hard and Soft Triggers

Let’s dig into the definition and value of a couple of these calculations which we discussed in a previous blog post that focused on Ryan Eyes’ Checklists

Concentration Limits – Portfolio, Index, and Country

Position limits serve to limit exposure to a given position and industry concentration limits serve to limit exposure to a given industry with most firms using these limits to track and ensure diversification.

Figure – Ryan Eyes Real Time Portfolio Assessment by Investment Category

Index, country, and portfolio concentration limits are not only monitored by Ryan Eyes’ software, but also reported on through e-mail, text, and visual alerts so that responsible parties are notified in real-time.

What are Hard and Soft Triggers?

Tracking the management of hard and soft triggers particularly those within the firm’s risk measures including liquidity and concentration is critical for funds to maintain internal compliance. Ignored triggers or triggers that did not initiate a response by the owner would be out of internal compliance and needs to be handled before a hard trigger is activated.

Ryan Eyes has an unlimited level of soft triggers that can be escalated up a chain. Fine-tune your soft triggers to a degree not possible with other systems so that you are not flooded with notices that are not relevant to you.

Automate Workflow Processes to Increase Fund Profits

Asset management firm managers have now been presented a far higher bar to clear in terms of convincing prospective investors that they can manage risks like those of a GameStop effectively. Clients have told us that they are operating in a vastly different environment post-Covid and GameStop than they had previously.

Asset management firms, particularly those with international investments may have a lack of data and transparency. In addition, Governments and regulatory agencies around the world are struggling as well to maintain their own operational integrity. That said, fund managers and advisors are ultimately responsible for maintaining workflow automation and need high-level visibility and risk analysis tools to effectively minimize risk and maximize fund profit. In addition, the solution they use must keep their analysts, fund administrators, and fellow fund managers in sync across what is now a dispersed organizational environment. Spreadsheets, diverse risk management tools, and system-based investment analysis inaccessible to team members and administrators are negatively impacting investing decisions and fund performance.

Improved risk management and productivity are generated by transparency and proactivity in the form of reports, alerts, and real-time risk calculations. This replaces the arduous, manual task of collecting, deciphering, and comparing information to benchmarks or firm rules and guidelines. Risk management and governance are now managed by an automated process that delivers data to a single platform reducing errors that are created by manual calculations and endless data evaluation.

 

Improve Risk Management with Automation & Transparency

Firms require an audit trail of operational processes and job completion for proper and effective workflow management. Confirmation that processes are within limits and verification that jobs are complete remove responsibilities from fund managers and administrators who can turn their primary focus back on risk management and compliance so that any “black swan” events like GameStop are considered in assessing overall risk.

A cloud-based, secure data management platform providing firm employees access and data and insights will increase control and management of the critical functions of a firm without adding complexity.

The reality is dozens of front, middle and back-office responsibilities arise with any investment strategy. Risk management, valuations, compliance, fund performance measurement, and compliance are being juggled at the expense of investment management focus. A cloud-based, secure data management platform providing firm employees access and data insights will increase control and management of the critical functions of a firm without adding complexity. In the GameStop, Covid environment streamlining operations and workflow is critical to maintaining focus on investment selection, managing risk, and generating alpha for funds.

 

 

Conclusion

The GameStop/Reddit event was certainly a wake-up call for many hedge fund managers who were not assessing risk outside of what they had experienced as normal. Frankly, retail investors bidding up the price of a stock that had been trending down for years simply was not on their radar screen. In addition, even though 130 percent of the stock’s float was short, the price trend, a relatively low beta of the equity, and certainty that the business model was dead lured managers into taking what they thought was a reasonable risk.

Tasks like modeling potential loss, calculating VaR, and tracking investments in terms of concentration in country, industry, or simply outstanding shares has been a manual task that is conducted periodically by many fund managers. The reality is that funds may be out of compliance concerning risk until a report is generated or an analysis of the positions is conducted.

Funds pay a price for being out of compliance for even a short time including investment losses from diversification issues and penalties. Ryan Eyes software provides the information, insight, alerts, and reports that keep fund managers informed in real-time and allow them to focus on investment decisions that not only comply with risk parameters but also deliver alpha for the firm and its investors.

 

To Learn More About How to Automate Operations and Manage Risk in Your Hedge Fund or Private Equity Operation – Contact Us, We Are Happy to Help – 1 (347) 759 0105.

You Can Also Fill Out Our Contact Us Form Here to Talk with a Ryan Eyes Consultant – https://www.ryaneyes.com/contact-us/

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