You are one of many portfolio managers for a large hedge fund. As you do every day, you've just reviewed the contents of your portfolio to be sure it contains only positions that you believe present attractive risk versus reward profiles from current levels, and considering your views and expectations, all are sized in appropriate proportions. Without warning, you receive an email from your CIO informing you that your capital allocation has been doubled, effective immediately. One of the positions in your portfolio has appreciated substantially since first putting it on several weeks ago. Having already realized the move you had initially anticipated, a few days ago you unwound all but 1/6th of the position, leaving the small remainder on in case the move continues.
In light of your new capital allocation, should you adjust the size of this position?
You are one of many portfolio managers for a large hedge fund. You have an excellent track record both as a producer and disciplined risk manager. While the fund has a policy of cutting capital allocations on a 5% drawdown, it is also well known that this speed bump is more relaxed for portfolio managers of your caliber. In fact, you've witnessed for yourself other portfolio managers who have been down more than 8% before having their capital allocation reduced. As a result, you decide to manage your portfolio as though the speed bump is an unknown, so as you have always done, as you recently began to experience a drawdown you gradually reduced the risk in your portfolio. Now down 4%, this has been a particularly bad run for you and management believes the stress is beginning to affect you. As a result, they've suddenly decided to reduce your allocation by 50%, effective immediately.
In light of the fact that you have been reducing your risk along the way, do you need to make any adjustments to your positions when your capital is unexpectedly reduced?
You are the CEO and CIO of a young hedge fund with several portfolio managers each managing independent portfolios. The end of your second calendar year in business is fast approaching and your firm has had a good run. So well in fact that if you were to close down all positions today, the performance fees alone would allow you to fully fund your entire business for another year, after all bonuses are paid out. Recognizing this as a crucial time in the development of a young hedge fund, you are inclined to reduce risk dramatically into year end.
Should you (a) tell all portfolio managers to reduce their risk immediately or (b) reduce capital allocations to all portfolio managers?