or by evaluating the structure of each instrument. Based on a leverage analysis, it is possible to determine an unleveraged equivalent portfolio. It is then possible to assess the risks of the unleveraged portfolio.

Because a hedge fund can be very leveraged, and because it should not be exposed to sector risks, verifying that a hedge fund is not taking certain risks may be just as important as determining which risks it is taking. For fixed income portfolios, risks can be calculated using standard valuation tools such as OAS. These tools can be used to determine the interest rate exposure (duration and convexity) of a portfolio, and even its sensitivity to different parts of the yield curve. Other analysis can measure spread risks and sector specific risk such as prepayment risk. While these tools may provide a good basis for risk measurement, they may not always provide the best measure of relative value, due to the uniqueness of the managers' strategies.

In evaluating hedge fund risk, we also focus on the degree of turnover. High turnover increases the risk of the portfolio, as it makes monitoring of the portfolio less reliable. For a high turnover strategy, past results may not provide a good indication of future risk. In addition, high turnover means that more frequent monitoring may be required to determine if the fund is taking on excessive levels of risk. The exception may be in quantitatively driven high turnover strategies that operate within very narrow risk bands. In that case, understanding the risk parameters may be the best risk measurement strategy.

Finally, the amount of disclosure provided by the fund is an important component of risk assessment. Some funds provide complete disclosure, these funds are said to provide a high degree of transparency. Other funds are opaque, providing little disclosure. In the middle are funds that are "translucent," providing partial, but not complete, disclosure. Translucent funds let sufficient light through to assess the risk of the funds, but also provide the managers with an ability to protect the value of their strategies.