Case 062Buy-side portfolio judgementHard

Hedge a Rs 50 crore long in Ornavi Specialty Tubes, which has no close listed peer. Given its betas to the market and to a capital goods basket, size the hedge and say what risk is left.

Balyasny Asset ManagementNew York · 2026

The situation

Your pod holds a Rs 50 crore long in Ornavi Specialty Tubes, which makes precision tubing for boilers and aerospace. No listed company does the same thing. Over three years of weekly returns, Ornavi's beta is 1.1 to the market index and 1.4 to a basket of capital goods stocks, and its correlation with that basket is 0.6.

Ornavi's volatility is about 40% a year and the market index's about 16%. The pod's risk manager wants market and sector exposure removed so the position is a bet on Ornavi alone.

Your task

Size the hedge, compare an index hedge with a basket hedge, and say how much risk is left and what kind.

Quick check

With the best basket hedge on, how much of Ornavi's volatility is left?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Short Rs 70 crore of the capital goods basket, 1.4 times the position; that removes market and sector risk but leaves about 80% of Ornavi's volatility. With a correlation of 0.6 the basket explains 36% of the variance. Volatility falls from 40% to 32%, Rs 16 crore a year of one standard deviation instead of Rs 20 crore. What remains is stock-specific, which is the bet you meant to own.

Step 1Why hedge with a basket rather than the index?

If you run an umbrella stall and worry about a dry season, you might sell sunscreen on the side. The closer your side business tracks the weather, the better it protects you. A hedge works in proportion to how closely it moves with what you own, so you pick the instrument with the highest correlation, not the most convenient one. Ornavi's betas imply a correlation of about 0.44 with the index against 0.6 with the capital goods basket, so the basket removes more of the risk you do not want.

Step 2How big should the short be?

Size the hedge by beta, not by rupees. A beta of 1.4 means Ornavi moves Rs 1.40 for every rupee the basket moves, so a Rs 50 crore long needs a Rs 70 crore basket short to be neutral. A rupee-for-rupee Rs 50 crore short would leave about 40% of the sector exposure in place. The same logic gives Rs 55 crore if you used the index instead. The minimum-variance hedge ratioThe hedge size that leaves the lowest possible volatility, equal to the beta of the position to the hedge instrument. is exactly the beta.

Residual volatility against hedge size: a shallow bowl, not a zero28%32%36%40%Best: short Rs 70 crore, vol 32%No hedge: 40%Double hedge: 40% againRs 0 crRs 35 crRs 70 crRs 105 crRs 140 crSize of the capital goods basket short against a Rs 50 crore long
The residual volatility of Ornavi hedged with the capital goods basket falls from 40% with no hedge to a minimum of 32% at a Rs 70 crore short and climbs back to 40% at Rs 140 crore, so the best hedge removes only a fifth of the volatility.
Step 3What risk is left, and is that a problem?

Split Ornavi's variance three ways. The market explains about 19%, correlation 0.44 squared. The basket explains 36%, so the sector adds about 17% beyond the market. The remaining 64% is Ornavi's own risk, and no instrument can hedge it without a close peer. That is not a failure of the hedge; it is the thesis. You own Ornavi because you believe something about Ornavi, and the hedge's job is to stop a sector sell-off from deciding your result.

What a hedge can remove, and what it leaves, share of the stock's varianceUnhedged19%17%64%vol 40%, Rs 20 croreShort Rs 55 crore index17%64%vol 35.9%, Rs 18.0 croreShort Rs 70 crore basket64%vol 32%, Rs 16 croremarketcapital goods sectorOrnavi itselfRupee figures are one standard deviation of a year's profit or loss on the Rs 50 crore long
Unhedged, Ornavi's variance is 19% market, 17% capital goods sector and 64% stock-specific; an index short removes only the market slice, leaving 35.9% volatility, while a Rs 70 crore basket short removes both, leaving 32%.
Rs 50 crore longHedgeVolatility leftOne standard deviation, Rs crore a year
No hedgeNone40%20
Market index shortRs 55 crore35.9%18.0
Capital goods basket shortRs 70 crore32%16
The basket hedge cuts one standard deviation of Ornavi's annual profit or loss from Rs 20 crore to Rs 16 crore, while an index hedge cuts it only to Rs 18.0 crore.

Add the practical limits. Betas measured over three years drift, so re-estimate them and rebalance the short when they move. The basket has its own stock-specific noise, which adds some risk back. And a Rs 70 crore short takes gross exposure to Rs 120 crore for a Rs 50 crore idea, which uses the pod's balance sheet and carries borrowing costs on the short side. Say those costs in the answer; a risk manager will ask.

Where candidates lose it

The usual loss is shorting Rs 50 crore of the index, rupee for rupee, and calling the position hedged. That ignores beta, picks the less correlated instrument and leaves most of the sector risk in place.

The second is promising that the hedge makes the position safe. With a correlation of 0.6, the best hedge removes a fifth of the volatility; say so before the interviewer does.

What the interviewer asks next

  • How would you build a custom basket that correlates better than 0.6 with Ornavi?
  • The basket's beta to Ornavi doubles in a sell-off. What happens to your hedge?
  • Would you size the Ornavi long differently once you know 64% of its variance cannot be hedged?

Asked at Balyasny Asset Management, Equity Research, New York, 2026 (Wall Street Oasis): How would you hedge this name that doesn't have a very similar public comp?

Company names and figures are illustrative.