The Hedgeweek Interview: Erich Bonnet, CIO, Portfolio manager, Kallista Arbitrage Strategies Fund: Rising up to challenges of multi-strategy investing
Erich Bonnet speaks to Hedgeweek at length about ADI's current strategies and future plans.
Erich Bonnet is Co-Chief Executive Officer and Chief Investment Officer of ADI. He founded ADI with Christophe Bourret in 1998. Prior to founding ADI, Erich was head of the interest rate options group at Banque Indosuez, before launching Transoptions Finance (1989, Crédit Agricole Group) where he was Managing Director and Partner. He developed the company to become a player in the market making of fixed income options on the MATIF (Paris), LIFFE (London) and MEFF (Madrid). In 1991, he launched Transoptions Gestion, specialising in convertible bond arbitrage funds, futures funds and in structured products with innovative capital-guaranteed products, distributed mainly by Crédit Agricole. In 1996, he joined Aurel, as Executive Director and Partner. He was head of the derivatives activity and the market making of convertible bonds. Erich is a graduate of the 'Ecole Supérieure des Sciences Economiques et Commerciales (ESSEC)'.
HW: What is the background to the fund?
EB: My business partner, Christophe Bourret and I founded ADI in 1998 with the support of a group of experienced derivatives traders and fund management professionals. Since, ADI has become one of the leading French alternative investment managers, with approximately EUR 4 billion in assets under management for 300 institutional investors.
Initially, the company succeeded in the development of a range of French registered funds offering superior risk-adjusted returns in strategies such as convertible arbitrage, global corporate high yield, merger arbitrage and credit arbitrage.
From this mix of absolute return, relative value-driven strategies, ADI has also been developing a range of multi strategy funds, where the investment manager selects the most attractive strategies run by the single strategy portfolio managers and invests more broadly in opportunistic macro-driven strategies. Three investment funds with various risk/return profiles belong to this range: Kallista Arbitrage Strategies (off-shore hedge fund, launched in May 2003), ADI Multistratégies (the first ever leveraged hedge fund 'à la française', May 2005) and ADI Best Of (moderate absolute return French mutual fund, April 2001).
The three funds are managed on a pari-passu basis, by a team of four experienced portfolio managers with both specific and complementary profiles: Cyril Castelli, Cyril Nedelec, Yann Couvet and me.
Like any other investment team of ADI, we take advantage of the 16 research analysts of the firm to help generating investment ideas.
As of end of January 2006, we manage USD 700 million within these multi-strategy funds.
HW: How and where do you distribute the fund? What is your current and targeted client base?
EB: Our main focus is on institutional and corporate investors. As a result of a dedicated and experienced marketing team, ADI has developed a direct marketing approach, favouring close relationships with a select investor base/network.
ADI is generally known on the international scene thanks to its range of Cayman-registered hedge funds, named Kallista. Actually, it's in 2000 that we decided to address international alternative investors, mainly in Continental Europe and the UK by offering a dedicated range of hedge funds to fuel our strategic development.
Kallista CB Arbitrage (Convertible arbitrage) was the first offshore hedge fund to be launched in December 2000. Since, Kallista Credit Arbitrage (November 2001) and Kallista Arbitrage Strategies (May 2003) have broadened our offer in hedge funds.
This is why ADI is active on select markets like Spain, Italy, Switzerland, Austria, Sweden and Finland, where financial institutions acknowledge our distinctive added-value proposition.
HW: What is the investment process of your fund?
EB: The Multistrategy portfolio managers implement an active management seeking to optimally exploit all market opportunities within a very broad investment universe and predefined risk limits. They enjoy considerable autonomy in their choice of style and financial instruments, whatever their risk/return profile, in order to achieve performance objectives.
ADI's Multistrategy funds invests in 13 strategies, belonging to 2 different investment styles, Directional and Relative Value/Arbitrages
The Directional Style involves taking advantage of opportunities detected during value analysis of instruments and expectations relative to the macro, microeconomic or technical environments:
- Interest rates
- Equities and stock indices
The Arbitrage/Relative Value Style aims at capturing a price spread between two securities, wherever such spread stems from a market anomaly or inefficiency:
- Capital Structure Arbitrage
- Credit Arbitrage
- Credit/volatility Arbitrage
- Merger Arbitrage
- Volatility Arbitrage
- Macro Relative value
- Equity Relative value
ADI's Multistrategy investment process is implemented on a continuous and interactive basis between all areas of portfolio management and research at ADI, with the Investment Committee, 'morning meetings' and internal team meetings being of central importance. It consists of four main stages:
1. Generation of investment ideas and investment themes
- Dual approach 'Top down' and 'Bottom up'
2. Investment style selection
- Medium or long-term directional
- Short-term Relative Value / Arbitrage
3. Construction of and active management of the portfolio
- Entirely discretionary and opportunistic portfolio allocation
- Optimization of each position in terms of risk/return
- Risk and position diversification according to investment objectives
4. Risk monitoring integrated into the investment process
- Definition of 'stop/alert' levels by position
- Opportunistic management of market risks
HW: How do you generate ideas for your fund?
EB: Acknowledging a more risk-seeking investment environment, ADI has gradually adapted its investment philosophy from early 2004, by integrating traditional investment portfolio expertises with its core 'trading-oriented' skills.
The Multistrategy managers rely on the research and analysis teams' conclusions. Assisted by these, they then make their own investment decisions, appropriate to each arbitrage or relative value strategy.
In order to identify investment themes and strategy ideas and form their medium/long-term directional views, they: participate in various committees and meetings for the respective individual portfolio management and research teams. They rely on macro tools and database, but also on the experience of the macro analyst well-integrated in the Multistrategy management team.
HW: What is your approach to managing risk?
EB: ADI's investment processes are diversified and require the use of complex financial products generally related to several markets (equity, volatility, interest rate, credit). Therefore, several indicators are used to measure those risks:
- Cash exposures consolidated per issuer, per sector, per strategy type…
- Sensitivities ('Greeks')
- Stress-tests also called 'what if scenarios' (credit spread widening or tightening, volatility and/or equity shifts, time decay)
- Computation of a Value-at-Risk
The latest method is particularly suitable for multistrategy portfolios as the VaR takes into consideration all the instruments and risk factors found in the different strategies.
HW: How/against what do you benchmark the performance of your fund?
EB: We really have an absolute return approach with our multi-strategy funds, and consequently no benchmark. As we are involved in a wide range of markets and investment strategies, we aim at producing steady returns, whatever the direction of equities, rates and currencies.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
EB: Having been initially invested in our own range of funds, we decided in the second half of 2004 to develop the Multi-strategy management process, moving from a 'fund of funds' approach to a entirely discretionary, direct investment multi-strategy management approach. This transition was achieved for our off-shore hedge fund in October 2004 and was further developed with the inception of the ARIA EL fund in April 2005 and our cash-enhanced fund on 1st July 2005.
In order to ensure the success of this transition, we have employed considerable means to:
- create a dedicated portfolio management team,
- reorganise research and analyst teams,
- define a new investment process and risk control procedures.
- In 2005, the Kallista Arbitrage Strategies Fund (USD) returned 12% with an annualized 52-week volatility of 5.1%, outlining an attractive Sharpe ratio of 1.94.
HW: What opportunities are you looking at right now?
EB: In 2005, we have focused our portfolios on directional strategies to make the most of an environment featuring a high level of risk appetite and consequently positively trending riskier markets, such as equities, the Dollar, Asian capital markets, etc. About two thirds of our 2005 performance derives from directional strategies and the rest coming from Relative Value/Arbitrage trades.
We foresee this proportion to reverse in 2006, as we expect markets to show more volatility and inefficiencies and therefore more investment opportunities. We do not exclude some temporary dislocation in overvalued markets.
These days, a few investment themes look interesting to us in terms of investment opportunities, mainly through a relative value approach. From the macro picture, we see some Asian currencies undervalued. From the micro economic perspective, we see credit spreads generally too tight, while the event-risk dragged by the merger & acquisition fever keeps on rising. Finally, expectations of sector and geographical rotation in equity markets favour relative value strategies.
HW: What events do you expect to see in your sector in the year ahead?
EB: For a while, we have been seeing rising interest from institutional investors for good multistrategy managers, which compete very favourably with traditional funds of hedge funds, in terms of return, transparency and fees. 2006 should confirm this trend.
HW: How will these changes/future events impact on your own portfolio?
EB: We have a very broad investment universe, in terms of markets, regions, and instruments. We don't expect investor inflows to impact our portfolio and our future returns. Our investment team is sufficiently sized and organised to keep the same quality of performance in the future.
HW: What differentiates you from other managers in your sector?
EB: Firstly, ADI is based in Paris, and that is not so common in our sector…!
More seriously, we believe that ADI's success derives from its genuine investment expertise in relative-value and arbitrage strategies, which has been strengthened by the regular addition of a top-quality fundamental analysis and a distinctive quantitative research.
In addition, the corporate business model has been, since the firm's inception, the key to successfully building the value-added process provided to investors (return extraction / risk control / management transparency / strong relationships), by aligning the long-term interests of ADI's partners and investors.
Finally, I would like to insist on our ability to adapt our investment processes and organization to a challenging environment. Within a year, ADI has significantly invested in its staff and raised considerably its research and analysis skills.
This commitment is certainly one of the major factors of the substantial performance recovery we enjoyed in 2005, with our fund recouping a 10% drawdown and overtaking its previous high water marks, without taking excessive risks. Very few managers can show the same record.
HW: Do you have any plans for similar/other product launches in the near future?
EB: Our three multi-strategy funds feature various formats and can fit the needs of many kinds of investors, from bank and insurance accounts to pension funds and private banks.
Globally, the firm is focused on extending the performance recovery of the past year and doesn't plan to launch new strategies.
As a matter of record, please note that ADI has successfully launched in 2005, two French registered hedge funds, ADI Situations Spéciales (Event Driven) and ADI Long Short Europe.
(Erich Bonnet was interviewed on 22 February 2006)
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