How multi manager firms hedge

Hedging in long-short equity portfolios differs significantly from that in derivatives portfolios due to organizational complexities. Multi-manager firms often rely on market hedging, which involves calculating hedge ratios based on well-understood market betas, leading to straightforward execution with low transaction costs. However, managing factor risks is more complex and costly, as factor portfolios only serve as proxies for true systematic market risks. Some firms opt for internal hedging, where portfolio managers (PMs) are tasked with staying within specified factor risk limits using a broad coverage of stocks. This can lead to compounded risks if PMs have correlated directional exposures. To balance this risk, firms can implement a hedge book at the firm level to counteract losses from prevalent factors like momentum. Alternatives include distributing momentum hedges to PMs, allowing them to manage their own hedges, or transitioning the responsibility for hedging back to PMs through various configurations. The approach a firm takes depends on its organizational structure and risk tolerance, with a compelling argument for internal hedging managed by a quantitative research team to ensure effectiveness.