Marketing Risk Versus Investment Risk: A Manager's Perspective

Hedge Fund managers risk millions, if not billions, of dollars every day. To better the world? Hardly. It is a business, and like any other business, they are out for profits.

If we were ruling out altruistic motivations, which more often than not we can, logic would dictate that a manager would optimize risk to maximize the profitability of the business. Surprisingly, this doesn't happen.

A New Perspective For Risk Management: Marketing Risk

Most managers are grossly over-weighted in investment risk.

Let me remind you, we are talking about the business of running a hedge fund, and the business is about growing AUM – if we are all being honest.

Therefore wouldn't it make sense to apply risk in the most appropriate form to grow the business? If this were true, risk should shift from investment risk over to marketing risk.

Think about it. Marketing risk is not unlike investment risk. You can choose to make the investment or not. The same analogy applies to the reward profile. The more marketing risk you take, the better chance of achieving outsized returns – in this case, growth in AUM.

I do acknowledge that we are talking about two different pools of capital, GP capital and LP capital.

I am simply making the point that GPs need to apply the same risk analysis they do for deploying LP capital to deploying their own capital. If they do, it becomes apparent that they are taking too much investment risk. In other words, too much of their money is subject to investment risk, and not enough is subject to marketing risk.

If managers start to think of marketing risk as a thing, as it pertains to the business of managing money, it becomes rather obvious that they are underweighted. Again, you don't get outsized investment performance without taking investment risk, and you won't get outsized marketing performance without taking marketing risk.

It is a very different way to think, but the logic is strong.