The Hedgeweek Interview: Philippe Bonnefoy, Director, Cedar Fund: Network of relationships provides competitive edge

Philippe Bonnefoy highlights the investment strategy and manager selection criteria for the Cedar Fund.

Philippe Bonnefoy is Chairman of the Asset Allocation Committee of Cedar Partners (Europe) Limited and Director of the Cedar Fund, a fund of hedge funds that he founded in 2002.   In 2001 he also founded Comas Management Limited which is the independent investment advisor for Alternative Investments to Commerzbank Corporates & Markets. Philippe Bonnefoy began his investment banking career as an analyst in international corporate finance at Kidder, Peabody & Co. in New York in 1983.   Subsequently, he transferred to a new London-based team that was to be responsible for the group's international fund management efforts, where he was responsible for international equity portfolio management. In 1988, he left Kidder and joined ex-colleagues in a newly created international risk arbitrage and macro proprietary trading group.  When he left in 1999, Bonnefoy was a member of the management board and Head of Trading.

HW: What is the background to your fund?

PB: Inception Date: May 2002, Current AUM: USD 230 million (as at end Jan), Domicile: Cayman Islands, Strategy: Relative value biased Fund of Hedge Funds, Targeted Annualised Volatility: 6-9%.

The Cedar Fund is an absolute return oriented multi-manager fund which targets minimal correlation to traditional asset classes.  The fund allocates amongst a range of primarily arbitrage strategies however macro, long/short equity and systematic futures may also be utilized.  The Fund employs leverage (up to 3x NAV) with the goal of enhancing the risk/return characteristics of the Fund.

HW: Have there been any recent events such as launches or changes/additions to the management team?

PB: Cedar Partners is developing its global presence. We have established our headquarters in Geneva and we have research offices in London and New York..  

We have established a great tactical asset allocation committee on which I am privileged to be joined by Lukas Muehlemann, formerly Chairman and CEO of Credit Suisse Group; and a risk expert, Professor Jacques Pezier, a Fulbright Scholar and Phd in Decision Theory and a DEA in Mathematical Physics.
 
In addition, in recent months several key new hires have been made. This includes Head of European Marketing, Claudia Wunschmann;  Head of Research & Due Diligence, Elisa Perna; and most recently, Head of Risk Management, Francesco Moresino.  All of these individuals have deep experience in financial markets, with relevant experience in their field of specialization.  The Group is driven by its strong investment process reflected in each of these new hires, as their areas of specialization have made our team and process even more robust.

Finally, we are focusing on creating new products which adapt to themes and opportunities in markets while providing our clients with the optimal risk/return characteristics.

HW: What is your investment process?

PB: Our investment process is driven by a top down asset allocation model.  Through the analysis of economic trends, geo-political developments and market pricing, the overall strategy selection is decided.  A strong, 'bottom-up', research driven, manager selection process is then employed to identify the best-of-breed managers within each strategy with a particular focus on those who have non-correlated performance.  A thorough level of qualitative and quantitative monitoring and research is conducted to ensure that the portfolio remains optimized and able to provide strong risk-adjusted returns.

HW: How has your fund performed? *

PB: Annualised return:  12.91% (since inception), Annualised Volatility:  8.27 %
(as of January 2005).

HW: How many funds are in your portfolio?

PB: The portfolio consists of approximately 70 funds invested in 10 strategies including distressed debt, long/short equity, credit arbitrage, fixed income arbitrage, event-driven, convertible arbitrage, systematic futures and mortgage arbitrage. Based on our top-down view, if we like strategies that are more volatile, we mitigate risk by constructing a portfolio that has very strong 'anti-correlation' characteristics.

HW: What makes a manager special enough for you to select him?

PB: The Cedar Fund pre-positions itself to take advantage of macro-economic themes identified on a 6-18 month forward looking basis.  The focus is on which strategies will be able to offer investment opportunities going forward rather than on where returns have been.  In addition to the top-down approach, rigorous micro-level analysis of individual managers ensures that each investment complements the overall portfolio strategy.

Performance of fund of hedge funds can be attributed to two factors:  the first is the fair reward from the market for a long-term exposure to risk factors and the second is the reward generated by the fund manager's talent at factor timing and fund selection.   In fact it was demonstrated by Amenc and Vaissié (Mathieu Vaissié. Do funds of hedge funds really add value for investors? Edhec Risk and Asset Management Research Centre. November 2005) that the strategic allocation of fund of hedge funds is the main determinant of performance.  Of the 97 funds analyzed by the team, 90% added value through strategic asset allocation while only 31% did so through active management.  In other words style / strategy allocation in combination with fund selection would provide the optimal portfolio.   This is what our portfolios are constructed to do.

Overall, a strategy must complement our global view on where markets are heading.  Strong manager performance is not enough to include it into one of our portfolios.  We are always asking ourselves, 'Is this the right time for a particular strategy?'

HW: What are your criteria for removing managers from the fund?

PB: We base our portfolio around a core group of managers and tilt our exposure towards strategies (managers) that we believe will enhance our returns with respect to changing market conditions. Because a forward looking, top-down strategy is maintained, such changes are made with the future performance over the next 6 to 18 months in mind.

Factors which would cause us to consider redemption include: significant unexplained changes in key personnel or systems, investment style drift, deteriorating performance, unsatisfactory risk management, sub-standard reporting or rapid growth in funds under management placing strain on the investment process.  

Through the combination of informal and formal due diligence techniques, impending problems in a hedge fund can be identified.  The informal discussions, ongoing review, manager meetings, and quantitative analysis allow us to gain insight into how each fund operates.  Though full transparency is not always available, managers in whom we invest are willing to share ideas and thoughts on their investment process, thus providing us with a high degree of comfort in their ability to follow-through on their objectives.  When a problem is identified, we are quick to speak with managers so as to assess if this is a fundamental problem or rather if this is due to a temporary dislocation in the market.

HW: How many managers do you have on the substitute bench?

PB: We analyse approximately 200 to 250 managers per year of which just over 100 are on our approved list.

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

PB: The year has been a difficult one for the hedge fund industry with most strategies struggling to deliver acceptable returns. Going forward though, we believe that macro, fixed income arbitrage and event driven managers will be presented with a number of interesting opportunities.  Interest rate cycles in G8 markets may well diverge.  Macro managers therefore have a number of opportunities to exploit in currency, fixed income, equity and commodity markets. We believe that a more trading orientated market will exist and those hedge fund managers that actively manage their risk, and are quick to realize fleeting trading opportunities, may well have the best success.  Furthermore, the disruptive price action caused by the impact of China on world consumer, commercial and financial markets may also create new opportunities for these managers.

Flattening yield curves, slowing growth, rising US interest rates, along with the potential of higher wage costs, will take their toll on US corporate earnings.  It is the US consumer that has driven world growth for the last few years.  As house price inflation slows and this spending becomes less robust, we expect to see a gentle rise in corporate defaults into 2006 and 2007.  Investors will demand a higher risk premium from markets causing a widening of credit spreads.  As a result, event-driven managers may find an increasing number of opportunities in this environment.

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

PB: Due to our top down approach, allocations will be altered to tilt exposure towards strategies that we believe will be most able to offer attractive risk adjusted returns over the next 6-18 months.

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

PB: With over 23 years of experience in trading, corporate finance and risk management, we have a unique perspective on both manager and investor goals. Furthermore, our network of relationships with senior industry professionals allows access to the industry's top-performing managers. The Fund is run by a team that has an understanding of trading risk and believes in the value of investment research and strategy having actually performed these functions previously. Thus, having actually done the job of the underlying hedge fund managers, we have a far better understanding of the risks and challenges involved in the industry.

As discussed above, we employ a tactical approach to strategy allocation.  The high level of 'hands on' macro-trading and specialised investment experience we have is unusual among fund of hedge funds and presents a significant competitive advantage in implementing the investment strategy.

HW: Some fund of funds have complained that managers are not taking enough risks in the current environment - what are your views on this, and on risk in general?

PB: Risk Management is a key function in any hedge fund organization.  Through our frequent interaction with managers, we see an increasing focus on risk management, with a particular focus on developing new tools to manage the various sources of risk in a portfolio.  In fact, managers are implementing stronger risk controls in their funds, and that is in line with what we expect to see as investors. We believe that managers are still taking risks, however they are monitoring these risks more closely than they did previously.

HW: Are investors' expectations moving upwards and how do you deal with this?

PB: The hedge fund industry will see a continued inflow of capital.  The number of institutional investors allocating to hedge funds will continue to increase.  Though traditionally dominated by high net worth investors, institutional investors are now beginning to dominate the asset class.

Institutional investors are less concerned with short-term, month over month performance.  Rather they are looking to match their assets and liabilities over the longer term.  Once an institution has made a decision to increase exposure to alternative investments, it does not reverse this decision due to poor performance in one quarter.  Hedge fund investments provide these investors with diversification and low correlation to traditional asset classes.  The investment returns provided by hedge funds are generated with lower volatility than equities and higher returns than bonds.

HW: Are you planning any further launches?

PB: We are continuously researching strategies that would be able to provide optimal risk / return characteristics for our clients.  Our research and due diligence team, through ongoing conversations with managers, are constantly thinking about new ways to structure innovative investment solutions to take advantage of trends we believe will exist in the near future, be it through asset allocation or specific strategies.

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