Systematic Risk Reduction & Drawdowns

This is the second paper in a three-part series. In the last paper, Drawdown Analysis, we saw that past drawdowns were a far-from-perfect guide to future performance. Still, many investors use past drawdowns when making allocation decisions. In this paper we examine one strategy for moderating drawdowns, systematic risk reduction, and ask whether investor behavior might be leading to unintended consequences. If investors use past drawdowns when deciding allocations, many hedge fund portfolio managers will adopt strategies that moderate drawdowns. If these strategies reduce long-term performance, then both investors and hedge fund managers may be worse off as a result.

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