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?
As CEO, your objective is to ensure the viability of the business. As CIO, you are tasked with maximizing returns relative to the risk taken in the investment portfolio, just as it is for each portfolio manager and the capital allocated to them. The CIO effectively manages a portfolio of trades like any other risk taker, assessing the merits of each component both independently and as part of the overall portfolio. In order to maximize the benefits associated with each portfolio manager, they should be allowed maximum autonomy within well defined constraints that they are able to account for in their planning and positioning. If we believe it is better to make decisions under certainty than uncertainty, then as CIO we should do our best not to be the source of uncertainty for our own portfolio managers. Therefore, the best answer must be "b". The only reason to opt for "a" would be to avoid responsibility and potential regret should the decision to reduce risk be seen as a bad one at some point in the future. The very possibility that any of these scenarios could invite debate serves as evidence of our very human preference for doing nothing.