A Pequot Postmortem: What is Headline Risk and How Can it be Avoided or Mitigated?

In the hedge fund context, “headline risk” may be defined as the potential for adverse publicity to undermine the business operations and investment strategy of a manager.  Headline risk is often invoked with a mixture of reverence and terror, one of the few trump cards that almost invariably will persuade a manager to make changes to a marketing presentation that otherwise appear ministerial.  The deterrent power of headline risk likely arises out of its vagueness: hedge fund managers generally are accustomed to modeling and quantifying the world, while headline risk remains inherently ambiguous – the stuff of rumor rather than reason – and thus difficult to measure or control once realized.  As demonstrated by the recent demise of Pequot Capital Management, headline risk can bring down an entire hedge fund management enterprise, even one with an admirable track record, and can tarnish otherwise sterling reputations.  However, managers are not without recourse – not defenseless against the fickle whims of the Fourth Estate.  There are specific precautions a manager can take to minimize both the likelihood of events that will result in headline risk, and the magnitude of the risk even if such events occur.  This article defines headline risk with more particularity, identifying its constituent elements and discussing the Pequot case as an example, then details the specific precautions managers can take to mitigate the likelihood and magnitude of headline risk.  It also discusses certain responses to headline risk that managers are encouraged to avoid.

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