Release date
15 March 2023
By Sergei Grechkin, Chief Risk Officer, UFG Capital Investment Management and member of the CIFA Ethics & Risk Management Committee
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Market Risk management in investments fund industry (Part 1)

Market Risk management in investments fund industry (Part 1)

For the Risk Management is always a challenge to predict the specific market risks that the alternative fund industry will face in 2023, as they can be influenced by a variety of factors such as global economic conditions, political developments, and unforeseen events. However, some potential risks that the alternative fund industry may face in 2023 include increased regulation, changes in investor sentiment, and shifts in the performance of specific alternative asset classes. Additionally, geopolitical risks such as trade conflicts, political instability, and natural disasters can also have an impact on the alternative fund industry. It is important for alternative fund managers to stay informed and actively manage these risks in order to protect the value of their funds and provide stable returns for investors.

Manage the risk

There are several ways to manage market risk:

  1. One approach is to diversify investments across different asset classes and geographical regions. This can help spread risk and reduce the impact of any downturns in specific markets or sectors.
  2. Another approach is to use risk management tools such as derivatives, hedging, and insurance to protect against potential losses. For example, a fund manager may use options or futures contracts to hedge against changes in the value of a specific asset or index.
  3. Additionally, active management strategies such as regularly monitoring the performance of investments and making adjustments as needed can also help to manage risk. This could include re-balancing a portfolio to ensure that it remains diversified or selling positions that are underperforming.

It's also important to have a proper risk management framework in place, this would include, risk identification, measurement and monitoring, risk mitigation, and risk reporting. Overall, managing market risk in the alternative fund industry requires a combination of strategies and a thorough understanding of the current market conditions and potential risks. Fund managers should always be monitoring the market and taking actions to protect the value of their funds and provide stable returns for investors.

Approaches to evaluate the market risk

One of the most common used quantitative analysis techniques to compute market risk in the Alternative Investment Fund Management (AIFM) industry is Value-at-Risk (VaR) and Expected Shortfall (ES).

  • VaR is a statistical measure that quantifies the potential loss of a portfolio over a given time horizon and with a certain level of confidence. It provides a "worst-case scenario" estimate of the potential loss and can be used to identify and manage market risks.
  • ES, also known as Conditional VaR, is an extension of VaR. It is a risk measure that estimates the potential loss of a portfolio in the event that VaR is exceeded. In other words, it calculates the expected loss when a portfolio exceeds the VaR threshold. ES is considered to be a more robust risk measure than VaR because it takes into account the tail risk or the risk of extreme events that can have a significant impact on a portfolio.

Both VaR and ES can be calculated using different techniques, such as historical simulation, Monte Carlo simulation, and extreme value theory.

AIFM use VaR and ES, in combination with other risk management techniques, to evaluate the level of risk in a portfolio and make informed investment decisions. This includes setting risk limits, monitoring portfolio performance, and adjusting portfolio allocations as needed.

Other approaches

It's important to note that, due to the nature of the Alternative Investment products, VaR and ES are not always sufficient to fully measure the risk of the portfolio, therefore, AIFM have to use a combination of other risk measures to have a more comprehensive view of the portfolio risk.

In addition to VaR and ES, AIFM may also use other risk management measures to evaluate the level of risk in a portfolio. These can include:

  • Stress testing: simulating extreme market scenarios to identify potential vulnerabilities in a portfolio
  • Correlation analysis: measuring the relationship between different assets in a portfolio
  • Volatility analysis: measuring the variability of returns in a portfolio
  • Value-at-Risk (VaR) and Expected Shortfall (ES) are not always directly applicable to Alternative Investment products, as these are usually illiquid and hard to value, therefore, AIFM may use other methods such as scenario analysis, sensitivity analysis, and gap analysis to evaluate the risk of the portfolio.

It's also important to note that the use of VaR and ES in AIFM is subject to regulatory oversight. AIFM are required to comply with the regulations set forth by the regulatory authorities, including the AIFMD in Europe, which include the use of risk management measures such as VaR and ES to ensure the safety and soundness of the funds.

Finally, effective communication with investors is also crucial in managing risk in AIFM. AIFM should keep investors informed of any changes to the fund's strategy or portfolio, as well as any risks that the fund is exposed to. This can help to build trust and confidence in the fund, even during times of market volatility.


Managing risk in AIFM requires a combination of techniques and an ongoing effort to stay informed and adapt to changing market conditions. VaR and ES are two commonly used risk management measures in AIFM, but they have to be combined with other risk measures, compliance with regulatory requirements and effective communication with investors. In Part 2 of this article, we`ll go through practical aspect of using VaR/ES in managing portfolio market risk.

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