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The Hedgeweek Interview: Stephen Dolbear, Senior Investment Officer, Alternatives, F&C Asset Management, London

Dr. Stephen Dolbear outlines the strategy and investment philosophy that underpins the F&C Amethyst Fund, an equity volatility trading fund.

The fund was launched on 15 January 2003. It had EUR 300m in AUM as of 30 June 2005 and has recently reopened to investment but is expected to close at around EUR 450m. The fund is the brainchild of Stephen Dolbear, the senior investment officer of alternatives at F&C asset management. He joined F&C Asset Management in 1995 and managed the High Income Plan, a unit trust with a derivative overlay, which laid the foundations of Amethyst.

Dolbear has a first class degree in Mechanical Engineering and a PhD in Computational Fluid Mechanics. Though he has the support and backing of F&C, the alternatives department is run like a boutique hedge fund business inside a top five asset management company - Dolbear has invested all his liquid net worth in Amethyst.

The hedge funds team of 19 are ring-fenced from the rest of the group while they run three single strategy hedge funds: F&C Amethyst, F&C Sapphire and F&C Citrine.

HW: How and where do you distribute the Amethyst fund? What is your current and targeted client base?

SD: Like most hedge funds we only market our funds to approved investors such as institutions, high net worth individuals and fund of funds. When Amethyst was launched in 2003, it managed only in-house asset. A year ago we took on a marketer, Alex Ingham Clark. One of his objectives was to diversify our investor base and he has been successful. Now 35% of the assets we manage are from external clients - our goal is to have a 50/50 balance.

HW: What is the investment process of your fund?

SD: The investment process is designed to identify profitable absolute and relative trade opportunities in the derivative markets, primarily in equity based instruments. Implied volatility is a key determinant of the price of a derivative contract and as such volatility is central to the investment strategy of F&C Amethyst.

Volatility is typically measured in terms of "standard deviation" which measures the spread of an asset's returns around the mean return. Volatility "implied" by the price of options quoted on a given asset is the market's forecast of future realised volatility. Implied volatility varies with both maturity and the strike price of the option. Implied and realised volatility also varies across asset classes, sectors and between individual securities. Options are typically quoted not only on individual stocks but also on most major market indicies. It is therefore possible, given the implied volatility, for the index and its individual components to determine the average level of correlation between stocks within the given index.

We have developed a range of quantitative tools to provide a forecast of the future direction of both implied and realised volatility, both for individual stocks and indices. These tools are driven by empirical price data which is captured and stored daily within the risk control system. The output for the tools facilitates the identification of new trade opportunities and also allows existing positions to be regularly re-appraised.

HW: How do you generate ideas for your fund?

SD: Because we are a statistical arbitrage fund we do not generate "sector" ideas in the way that an equity long short fund might. We use three types of trades to generate returns for the fund: relative and absolute implied volatility, dispersion positions, and other option pricing variables.

We described the way we use implied volatility above. These positions are typically kept on for six to eight weeks.

We also trade dispersion positions which are a type of correlation trade which use single stock and variance swaps on indicies. Dispersion positions are kept on for two to three months.

The third trade type we use is more opportunistic and long term typically one year or more. As we are a consumer of risk - market makers regularly offer us interesting positions. Only 10% of our fund may be invested in this final trade type while up to 100% may be invested in the first two - depending on the state of the market.

HW: What is your approach to managing risk?

SD: Internal limits are set for the Greeks i.e. Delta, Gamma, Vega and Rho (if applicable) and imposed on the fund. The Greeks are measured and monitored on a daily basis at the fund level and the index level. The portfolio is shocked and stressed periodically to ensure that there is enough liquidity in the market to allow the fund to hedge its positions in extreme market movements.

HW: How/against what do you benchmark the performance of your fund?

SD: Amethyst operates in a sophisticated, niche area where there are very few seasoned professional and high barriers to entry. Therefore, we do not use a benchmark or measure our performance against our peers. We aim for a 1% (annualised 3 month Eurolibid +10%) return each month. To 30 June 05, Lipper/Tass shows the 12 month return on the fund was 11.75% - just shy of our target. Over the last 30 months, we have only had 3 months of drawdowns - a record we are very proud of. We won the EuroHedge award for best Mixed Arbitrage& Multi-Strategy category for 2004.

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

SD: Yes, our performance for 2004 was 13.25% (Lipper/Tass) - this hit all our targets and we are really pleased about that. It has been a bit slow this year but we haven't lost any money and we are confident that we will finish the year on target. We do not expect our performance to change just as we do not expect our style to change.

HW: What opportunities are you looking at right now?

SD: One of the exciting developments in our markets was last year's introduction of options on variance contracts. This market is deepening and we are finding more opportunities to use this instrument.

HW: What events do you expect to see in your sector in the year ahead?

SD: The last few months have seen historic lows in the volatility of the markets. The press has been chattering for some time now about the return of volatility to the market. The market tends to think there is a crisis overdue but we are just trying to manage our funds in an intelligent and risk-aware way.

HW: How will these changes/future events impact on your own portfolios?

SD: An increase in market volatility will not markedly impact our fund in the short term but over the medium term it will potentially create more opportunities for implied volatility trades.

HW: What differentiates you from other managers in your sector?

SD: I think my edge lies in the composition of the portfolio and the analysis of the trades. I have nine years experience in structuring portfolios based on these investment strategies. I spent the nine years before those structuring similar trades at various investment banks. This experience is especially valuable when derivatives markets are stressed.

HW: Do you have any plans for similar product launches in the near future?

SD: F&C has a platform in place and we will continue to look at bringing on new products.

In the next few months, we will begin marketing our long/short fund F&C Citrine. F&C Citrine launched a year ago but we are just beginning to take in external money. F&C Citrine is managed by Frederic Desage-Bonnet.

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