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The Hedgeweek Interview: Gilles Frisch & Gabriel Andraos, Dexia Asset Management: Being rewarded for innovation

Gilles Frisch and Gabriel Andraos believe the 'credit market - neutral' feature of their strategy sets Dexia Credit Arbitrage apart from its competitors

Gilles Frisch, heads credit arbitrage in Dexia Credit Arbitrage. Gilles trained as an engineer from Ecole Polytechnique and obtained a diploma from ENSAE in Paris. Gilles worked in the financial engineer trading room in Paribas Capital Markets and in the Quantitative researcher trading room in Société Générale. He joined Dexia Asset Management as a Fund Manager in 1996.

Gabriel Andraos did a Diploma in Economics from the University of Georgetown, USA in 1992 and an MBA from the University of Harvard in 1998. He worked as financial analyst high yield and restructuring in Merril Lynch & Co, New York in 1993 and then as Private Equity Manager with Merril Lynch & Co in Hong Kong and Bangkok. In 2001, Gabriel worked with an independent Hedge Fund, developing research tools in Long Short Equities in Europe and United States. He joined Dexia Asset Management as Credit Arbitrage Fund Manager in 2003.

HW: What is the background to the fund?

GF & GA: Launched in October 2003 in order to capitalise on its ability to select and analyse high yield credits, Dexia Credit Arbitrage relies on a process permitting the exploitation of inefficiencies on the credit markets and divergences between credit and equities. Fund assets were €155 million in mid-March 2006.

The management team consists of two experienced managers, supported by five high yield credit analysts and three analysts from the quantitative analysis team.

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

GF & GA: Dexia Credit Arbitrage is marketed in Europe by our own sales teams. Target clients are essentially institutional clients, insurance companies and banks for their own funds as well as funds of funds.

HW: What is the investment process of your fund?

GF & GA:
The investment process relies on an active allocation between three strategies, which enables the risk-return ratio to be maximised. These three strategies are long/short credit with the implementation of pair trading strategies, relative value credit arbitrage with arbitrages between two bonds from the same issuer and finally capital structure arbitrage, namely between the company's equity and its debt.

To that end, a quantitative filtering of the investment universe so as to detect potential opportunities completes the bond selection process implemented in high yield management. Once those opportunities are detected, they are subject to a complete credit analysis in order to determine their relevance and their possible inclusion in the portfolio.

HW: How do you generate ideas for your fund?

GF & GA: We use a 2-step approach to generate ideas. First we run a set of quantitative tools in order to spot the best arbitrage candidates within our universe of liquid high yield credits. We then rank these potential opportunities according to their risk-reward and we submit them to a complete Fundamental analysis to validate the quantitative outcome.
HW: What is your approach to managing risk?

GF & GA: At Dexia AM our alternative management teams have the task of developing products responding to the requirements of investors seeking attractive and stable returns associated with controlled risk. To that end, we have established an independent and targeted risk management entity, in order to ensure constant control of all the funds and mandates, the tasks of which are most varied and include the realisation of stress test scenarios to assess the incidence of catalyst events, to fix the appropriate limits for each investment process and to validate those risk-return objectives prior to launching a new structure.

For Dexia Credit Arbitrage, risk monitoring revolves around three major axes: active management of the lever and classic risk parameters, limits leading to a significant diversification and the implementation of a real sales discipline.

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

GF & GA: Dexia Credit Arbitrage is an absolute performance fund with a performance objective of 10%-12% and a maximum volatility of 10%. As yet there is no relevant index of comparison for credit arbitrage funds, a category which only includes a dozen European funds.

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

GF & GA: We have been running this strategy since late 2003. 2004 performance was in line with our objectives. 2005 was mixed as the May 2005 credit crisis led to a flat first semester. The second semester of 2005 and the first quarter of 2006 were in line with our objectives however. We don't anticipate changing our performance objectives or style going forward.

HW: What opportunities are you looking at right now?

GF & GA: We are looking for opportunities that allow us to get long mid-beta credits versus short high-beta credits, to get long secured debt versus short unsecured debt and to get long senior debt versus short subordinated debt. We are more particularly targeting those sectors that are experiencing an increase in dispersion among individual credits such as the chemicals, cable, telecom and gaming sectors. Looking at individual credits, we focus on names with rich capital structures containing secured, unsecured and subordinated debt such that we can play one part of the structure versus another.

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

GF & GA: Currently, the high yield market is trading at spreads that are close to historical tights with limited dispersion among individual credits. As global long-term interest rates rise however, the market may become less supportive of current spread levels and both volatility and dispersion should pick up significantly. Importantly, the high yield market is also quite sensitive to equity market levels and volatility. An unexpected downturn in equities could also lead to a correction in high yield and an increase in dispersion.

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

GF & GA: In order to successfully implement our relative value approach, we need dispersion among individual credits. We are running our portfolio with a very low level of risk until we see more dispersion, at which point we will have a significant amount of capital to put to work.

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

GF & GA: Our key differentiator is the 'credit market - neutral' feature of our Fund. This essentially means that we hedge any residual exposure to the high yield market for the Fund as a whole. This feature has allowed us to historically exhibit strong negative correlation to the high yield market (-25%) during difficult months (when the market or our Fund was down). As a result, our market-neutral approach can help diversify an otherwise long credit exposure with a product that protects capital or has made money on average when high yield was down.

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

GF & GA: Dexia AM is recognised in the field of alternative investments for the considerable capacity for innovation it has shown since 1996, and also for the synergies benefiting the different management processes (equities, credit, credit derivatives, options). The launch of a new management process, on average every eighteen months, is a strategic choice, which is well received and often recognised by many awards.

After the launch at the end of 2005 of Dexia Leveraged Loans investing in leveraged loans, bank loans concluded between banks and companies of the high yield type, and Dexia Long Short US Equity, a strategy consisting of the discretionary selection of North American equities, Dexia AM is now launching Dexia Global Event Fund, an 'on-shore' lever-effect fund which will give event driven exposure through equities, convertible bonds and corporate bonds.

(Gilles Frisch & Gabriel Andraos were interviewed on 13 April 2006)

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