Arié Assayag outlines the thinking and strategy behind the global development of SGAM AI hedge funds and funds of funds business, plus forthcoming launches.<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
HW: What is the background to the Alternative Investments business at SGAM?
AA: We are a wholly-owned subsidiary of SGAM. Within the Alternative Investments division we have four main units:
1) Structured Asset Management: This covers all structured products and is the oldest division with 78 people and assets under management of EUR 20 billion.
2) Private Equity: Started around seven years ago and currently has 52 people with assets under management of EUR 1.1 billion.
3) Hedge Funds: This unit, for which I am responsible, was started a little over five years ago. It currently has EUR 3.7 billion in assets under management as of March 2005.
4) Real Estate: Our newest unit - launched a couple of years ago - currently with assets under management of EUR 155 million.
The Alternatives Investment division is presently based in <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />New York, London, Paris, Tokyo and Hong Kong.
HW: What is the focus of the Hedge Funds unit?
AA: When we launched this unit just over five years ago we decided not to acquire the hedge funds expertise by buying another company, but instead to develop the expertise organically.
We gathered a very credible group of experienced people coming from three different areas, namely, capital markets & investment banking, proprietary trading and traditional asset management.
When we launched the Hedge Funds unit, we defined ourselves as followers with the objective of becoming market leaders.
For the first couple of years, the two areas we developed were funds of hedge funds - which we decided to do out of New York - and single strategies, which we do mainly out of Paris.
We focused in this first phase on building products that could best be described as 'average' in terms of performance, with relatively low risk and credible processes, so that we could build a track record and also develop investor confidence.
We completed the first phase by the beginning of 2003, and we then deployed a strategy both in the funds of hedge funds business and in the single strategy business, with two objectives:
- First, to develop a business where we can create value over the medium to long-term, or for the next 5-10 years;
- Second, to use SGAM's established identity as a 'global asset manager' as best as we can, because that is what our customers, be they retail or institutional, expect from us.
HW: How do you expect to create value?
AA: We feel that the value in the hedge funds business is going to be found in businesses where the growth in assets or capacity constraints is not going to hamper generation of alpha.
The top 20-60 hedge funds have shown very little asset growth, well below the industry's growth average, which is 20-25% year-on-year.
Because of our long-term commitment and SGAM's global asset management capabilities - we have USD 410 billion under management globally - we have access to significant capacity and we do not face the constraints faced by many of our competitors.
We even created a fund of hedge funds product - called SGAM AI Premium - to reflect this strategy. Last year this product, which is managed out of New York, returned 15% gross on an average of 20 hedge funds, with the worst month of -40 basis points.
This fund of hedge funds product has had a significant influence on our whole range of products. The fund's strategy is based on the following premise: the more that people enter the market, the lower the average performance is going to be. Also, the more people that enter the market, the higher the dispersion between good products and bad products.
Basically, the 'good' funds are averaging 10-15% against an average of 3% across the industry, so the fund's skill is to focus on identifying and allocating only to the good or 'premium' funds.
The second leg is where we see there is no problem of capacity related to performance - this is to be found on the high end of the evolving managers. Access to this market is very difficult, however last year we introduced a product - called Discovery Fund of Funds - that offers access to these high-end evolving managers.
And, at the end of June this year we are launching a second product out of New York that will act as an incubator for ten hedge funds with USD $1billion of seed capital or an average investment of USD $100 million. We already have two hedge funds in the pipeline for this incubator product and we are looking to have a full complement of ten funds within 12-18 months. The focus will be very strongly on the US with some opportunities in Europe - we will not look at Asia at the moment. We are targeting potential managers who can have an impact immediately.
HW: What are your other fund of hedge funds products?
AA: We have a broad range of 15 fund of hedge fund products offering different risk profiles; different concentrations of funds ranging from 20-50 funds; a choice of jurisdictions including Dublin, Luxembourg and the US; and strategy concentrations such as equities, relative value global markets and most recently, portable alpha.
HW: What is your vision for the Paris-based single strategy funds unit?
AA: It is similar to the plan for the fund of hedge funds unit, where we want to create value over the medium to long term.
We are building a single strategy product range that will reflect the three key skills a global asset manager like SGAM is going to be able to deploy:
- First, we have a lot of talent in traditional alpha-generating areas such as stock-picking within the group. We want to develop hedge fund products around these stock-picking skills in the long/short and market neutral areas.
- Second, we have strong credibility and skills in identifying, measuring and controlling risk, and we can build hedge fund products around these skills.
- Third, we have a strong tradition of skills within SGAM for volatility and quantitative strategies.
SGAM has taken a leadership role in these areas over the past 20 years and this is reflected in the experience and skills of the hedge funds team. For example. I started in 1986 in SocGen's derivatives department and spent 15 years in volatility trading and derivatives market making.
HW: How do you put your team's skills in volatility to work?
AA: We use our knowledge of volatility to enhance the product. For example, the prediction of a product's performance relies more on the accurate prediction of volatility than the prediction of direction. If you want to know how a long/short is going to perform, you will look to assess the volatility of the equity.
HW: How did you deploy SGAM's traditional stock-picking strengths?
AA: We have deployed a number of long/short and market neutral products using three areas of stock-picking expertise, namely:
1) European equity - we have one of the best traditional European stock-pickers in James Livingstone, who has been managing long/short Europe for us over the past three years out of Paris.
2) We have a systematic stock-picker by the name of Franck Vivier who was in traditional asset management before joining us four years ago.
3) We are using SGAM UK for long/short UK stock-picking.
Our long/short and market neutral fund managers are the stock-pickers, and this strategy has paid off. For example, our long/short Europe product returned 8.2% last year with a volatility of 5.
We have also developed tools around the manager, such as Fund Builder, which optimises the portfolio, and a tool called Risk Manager, which measures risk on the manager's positions.
We have additionally strengthened the European hedge funds area by hiring Emanuel Ribeiro de Figueiredo, previously the pan-Europe Head of Research at Morgan Stanley for six years, to strengthen the generation of ideas in this area.
We intend to further develop the long/short and market neutral areas based on this business model.
HW: What other single strategy hedge product areas are you developing?
AA: The next area comprises relative value products, where we have three groups of strategies.
- The first and most common type is volatility arbitrage around the convertible, where you have long convertible volatility, volatility arbitrage on the index, long/short on single stock options and dispersion.
- The second group is volatility arbitrage diversified across macro underlying on the forex, fixed income and equity indices.
- The third group comprises volatility overlay strategies, such as equity protection or liquidity protection strategies.
HW: How do you differentiate these relative value products from those of your competitors?
AA: With regard to the second group of volatility arbitrage strategies diversified across macro underlying, we are highly specialised and unique in our approach.
People are dying to find arbitrage opportunities and there is saturation in a lot of areas such as stat arbitrage, fixed income, convertible and risk arbitrages.
However, I can tell institutional investors that there is one area - the options market - which has a turnover of USD 1 trillion per day and no investors, only market makers, plus market users who are mainly hedgers - people who use options to insure their risk - and speculators.
There are no investors using this market to capture long-term value using 'golden investment rules' such as diversification and risk management.
So it's a great opportunity for someone who can capture that value and bring investors to this large asset class - that is what we are doing and that is also what differentiates us from our competitors.
HW: What is your process for offering investors access to this USD 1 trillion options market?
AA: The process is not complex and very conceptual. An option is comparable to insurance, where it is priced according to the statistical risk that is taken. It is obvious that if the price of the insurance is higher than the cost of the statistical risk, the insurance company is making money. The options market works in a similar manner.
We look at around 26 different underlyings when we assess the options market and we are, in simple terms, building a process where we sell when it is expensive and buy when it is not so expensive, creating a balanced, opportunistic options portfolio to try to capture the excess value.
We include some very sophisticated features such as our knowledge of the relationship between the volatility and the spot, which we know very well because we have monitored this relationship since the early days of the option markets
Every component of the process is defined conceptually and validated quantitatively; therefore the process is combining qualitative and quantitative expertise. This balance differentiates us from conventional volatility arbitrageurs who are trying to go long on single stock options, which is probably the worst space to be in the options market, and one which we have deliberately avoided.
Obviously our process is an arbitrage, and the arbitrage or return is going to be a function also of our access to liquidity and our ability to control transaction costs. We have some of the best traders within SGAM and we are able to access the market in a very efficient manner, which increases the profitability of the arbitrage.
HW: How will you handle the risk in the options portfolio?
AA: Investors are obviously going to be very concerned about how the risk is going to be handled in the portfolio - risk management is very important.
The fund managers in our programme have been managing USD 50 billion portfolios for banks (including exotics and complex risks)- our portfolios of liquid and plain vanilla options on short term maturities are relatively easy to manage and our risk management therefore is very strong.
We also know from experience that European underlying has to be traded in Europe and US underlying has to be traded in the US, and the same applies to Asian underlying - you have to be where the underlying is moving and we are present in all these markets, constantly tracking and trading.
HW: What products are you developing to offer investors access to the options market?
AA: We have developed products for the institutional market with daily liquidity and modest return objectives in the region of Libor plus 300-400 with low volatility of around 4.
The past 14 months was a tough time for volatility arbitrage with a lot of funds going bankrupt and the FIMAT Volatility Index down 14 months in a row. Over that period we achieved a flat return for the low, liquid diversified fund and 9.5% for the concentrated equity index arbitrage fund. This shows a much disciplined risk management and process.
We are now ready to launch a hedge fund product constructed around this volatility arbitrage theme. It will be a Dublin-based product offering a 15% return with a volatility of 8. It will feature monthly liquidity and will be targeted at funds of hedge funds. It will be launched with USD 75 million of our own money and will be marketed in Europe, US and Asia.