Last year the $18 billion Common Fund was rocked by revelations that Kent Ahrens, a rogue trader at First Capital Strategist, had lost $138 million in a Barings-like maneuver. Ahrens, like Barings' Nick Leeson, was only authorized to do arbitrage, but ended up losing the money in a directional play.

In February the Westport, Connecticut-based fund decided it was time to bring in a new broom. It hired Todd Petzel, 44, an executive vice president at the Chicago Mercantile Exchange and now a member of the fund's board of directors.

Petzel hit the ground running. Early in his tenure the Common Fund initiated a search for a senior risk management officer and began forming an internal risk management team for overseeing all outside managers.

The risk management team pioneered an on-line reporting system with Mellon Bank, its custodian, which contains automated guidelines for compliance. Instead of relying on the fund manager to make sure its traders follow the Common Fund's investment guidelines, the custodian checks each trade's compliance as it is reported.

"We want to automate the guideline process and make it day to day rather than month to month," explains Petzel. He believes the internally developed system, which is being beta tested at Mellon, would have stopped the rogue trader as soon as he submitted his trades to the custodian.

Petzel, who joined the Merc as an economist in 1988, is no stranger to high-tech risk systems. While at the CME he helped develop a futures margining based on risk that has become a standard for other exchanges.

Derivatives are still part of the Common Fund's investment guidelines. Common Fund investment managers have $2.5 billion in derivatives on the equity, fixed income and currency side. Of the $2.5 billion set aside for derivatives, there is always $25 million in cash which the Common Fund directs to be invested in the S&P Stock Index futures because of the fund's commitment to remain fully invested at all times.

A lot of water has passed under the bridge in the derivatives marketplace since Morgan Stanley managing director Bidyut Sen entered the business. Sen was on the team that arranged the World Bank's pioneering $400 million currency swap in August. 1982. "Not many people who were there at the beginning are still around in the business," muses Sen.

Sen recently left the fixed income division to become global head of Structured Asset Management within Morgan Stanley's asset management division. "After 10 years of running a derivatives products business, I needed a new challenge," he says. "I wanted to take financial engineering into new areas, and asset management is an area where the use of structured products has not been fully exploited."

Sen is currently assembling a team of portfolio managers and research people for his new group. His first fund was launched in March in response to a growing demand for enhanced index funds by plan sponsors. The fund aims to outperform the Standard & Poor's 500 Index by 100-150 basis points through an active stock selection process driven by mathematical models. A second "market opportunity" fund will take advantage of valuation discrepancies, looking for special opportunities in fixed income, currency and equity markets. This fund will use conservative leverage and sophisticated risk control techniques in its portfolio management.

Scores of hedge funds are born each year, but few offer something distinctively different. Spectrum Global Asset Management promises to be an exception. Rather than underplaying their derivatives know-how, Spectrum is ready to flaunt it.

Spectrum, which began trading last month, was founded by Guillaume de Dalmas, 39, a former director of international fixed income, financial futures and options at Merrill Lynch; Harvey Rosenstock, 45, a former managing director at Credit Lyonnais; and Chris Evans, 37, a former partner with hedge fund Omega Advisors. De Dalmas's departure from Merrill is the latest in a long line of senior defections that has weakened the fixed income and derivatives divisions.

Spectrum will invest primarily in global government bond markets and their listed futures and options. It is interested in only the most liquid of assets, and will not, for example, buy any emerging markets instruments, index linked bonds or junk bonds.

De Dalmas says derivatives will allow Spectrum "to paint pictures in color rather than black and white," and to avoid the kind of mistakes other hedge funds can make. He believes, for example, that many hedge funds misunderstood the relationship between the French franc and German mark forward swap curves. As a result many traders shorted a 70bp differential between the French and German curves in the mistaken impression that they were putting on an arbitrage trade. In fact they were simply putting on a directional play that quickly went sour. Spectrum wouldn't make this kind of elementary mistake, de Dalmas avers.

Spectrum also hopes to avoid what de Dalmas calls "the star system." He and Evans have identical jobs trading the market, while Rosenstock takes care of everything else, such as marketing and legal matters. Every major trading decision, however, has to be agreed upon by two of the three principals.

A domestic version of the fund began operations with $7 million under management, and an off-shore version with $25 million is slated to start soon. Eight European institutions have expressed firm interest so far, with other investments expected from money managers, insurance companies, state funds and some private individuals. The firm has set a limit of $500 million on the funds, but says assets are unlikely to top $250 million for the first couple of years.

Spectrum aims to generate profits of 20-25 percent per year without incurring losses that exceed 5 percent. It will charge an annual management fee equal to 1 percent of the net value of the assets. The fund says it will employ leverage, but does not anticipate that this will exceed three times capital.

A couple of months ago Charles Taylor, 46, quit his five-year position as executive director of the Group of Thirty to join Andersen Consulting's risk management practice. The G30 think-tank, it will be remembered, issued a landmark study on derivative usage in July 1993. The hire is meant to signal to all the world that Andersen sees a lot of potential in this area. Taylor concedes that risk management is already crawling with consultants of all shapes and sizes, many using the G30 principles for audits of corporates. But he won't be chasing those run-of-the-mill engagements. Instead he plans to serve the carriage trade.

The English-born Taylor, a former Prudential Securities economist and partner in Britain's Deloitte Haskins & Sells, will be prospecting among a total of no more than 200 global institutions who might need-and must be able to afford-very large-scale, big-ticket engagements designed to integrate all aspects of risk. Taylor believes he will be successful because "risk management is not fully integrated and not fully rolled out in many firms," he says. "Credit risk and market risk are usually not fully integrated, and the best practice in each area is not influencing the other. In many cases the values of a risk-sensitive culture do not permeate the whole institution."

A handful of institutions who've tried the integration route have run into major obstacles. "Some risk managers have gone a certain distance down the road but are beginning to bang into barriers that require some facilitation," Taylor says. "I think that is where firms like ours can play a useful role."

The bad press that derivatives has received is an ill wind that could create profits for money managers. That, anyway, is the word from Andrew Parker, 38, the latest recruit of BEA Associates, the $55 billion New York-based money management firm. "There is an opportunity for mispricing in derivatives that's indirectly related to the attention the market gets," he says. "Because fewer institutions have focused on derivatives, due to recent negative publicity, the likelihood of mispricing is greater." This mispricing enables Parker to make relative value bets and to add returns to the firm's enhanced equity index fund.

Parker started his career marketing derivatives at Salomon Brothers in 1980, and went on to stints in Drexel Burnham Lambert's equity index product group and in Morgan Stanley's London office. Most recently he was a principal in Morgan Stanley's New York office, where he was responsible for marketing equity international derivatives to U.S. clients.

At BEA his responsibilities will include portfolio management and derivative product development. His first job has been to work on the design and marketing of an equity index annuity product designed for insurance companies.

Parker seems unfazed by the trend of plan sponsors to stray from active managers in favor of passive index funds. "While pension funds may be reevaluating active managers, I've seen a trend among plan sponsors to switch from plain vanilla index funds to enhanced index funds," he says. "BEA has managed derivatives for 15 years, far longer than other derivative managers, which I believe makes us unique. While we have a loyal client base, we aren't sure the marketplace as a whole recognizes our derivatives capability."