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Alternative Investments - March 17, 2006

New Standards for Alternative Investment: An Interview with Frédéric Ducoulombier, Director of EDHEC AI Education

In this month's interview, Frédéric Ducoulombier, Director of EDHEC AI Education talks to us about the need for educational standards in the alternative investment space, the growth of the Chartered Alternative Investment AnalystSM programme, and the new Lhabitant and Martellini Advanced Hedge Fund Investing seminar.

18 months ago, the EDHEC Risk and Asset Management Research Centre set up Edhec AI Education as its executive training arm to “help professionals upgrade their skills to meet the challenges and seize the opportunities of the rapidly expanding alternative investment universe.” Have the challenges and opportunities you then described materialised?

Frédéric Ducoulombier:
Our premise was that explosive growth in the funds flowing into alternative investments, institutional investors’ increased appetite for the various alternative vehicles and calls for greater regulation of hedge funds would heighten the need for professional standards within the industry.

All of these have been confirmed.

2005 was a year of very strong growth for alternative investments: preliminary estimates1 point to 50% growth in A.U.M. in the hedge fund industry, private equity enjoyed a record fundraising year with buyout funds at an all time high and venture capital firms at their highest level since the burst of the dotcom bubble2, and the global real estate market rally continued.

Alternative investment growth is fuelled by institutional investors who are increasing their commitments to non-traditional asset classes, with hedge funds leading the rise – acceptance of hedge funds by European institutional investors has increased markedly and 51% of them are now exposed to hedge fund strategies which, on average, represent 7% of their global assets3.

Calls for greater regulation of hedge funds were heard when the S.E.C. in the U.S. amended the Investment Advisers Act of 1940 to impose registration upon hedge fund advisers; adopted in late 2004, the new framework came into force on February 1st, 2006 and is imposing new compliance requirements upon hedge funds.4 While regulators worldwide are taking a closer look at alternative investments to determine how best to regulate them – sometimes with ambitious plans to modernize the legal, regulatory and administrative environment that may be hampering their development5 – fraud cases concentrated at a few small US hedge funds have attracted a large amount of media attention and triggered fresh calls for stricter regulation of the industry.

Against this backdrop, we reaffirm that an expanding industry needs an expanding base of professionals serving customers, but there is a risk to the community if knowledge and skills are allowed to lag behind. The alternative investment industry needs trusted professional standards that demonstrate mastery of the fundamental concepts and tools for managing assets across the whole spectrum of alternatives, as well as venues that allow professionals to keep up with the rapid pace of innovation.

So far, how have you contributed to promoting these high professional standards?

Frédéric Ducoulombier: First, it is important to underline that the EDHEC Risk and Asset Management Research Centre as a whole has been contributing to this objective through its research for business orientation and its constant dialogue with practitioners. EDHEC AI Education has fulfilled its mission by promoting awareness of the CAIASM programme – the alternative industry’s global educational standard – and delivering executive training courses across Europe. Globally, the number of candidates preparing the Chartered Alternative Investment AnalystSM examinations more than doubled last year with Europe recording the fastest growth. Since inception, we have helped hundreds of professionals pass their CAIASM exams. Practitioners from more than a hundred institutions have taken part in one of our CAIASM review courses or in the more specialised hedge fund training seminars we organise.

Tell us more about the CAIASM programme and the type of support you offer candidates…

Frédéric Ducoulombier: Sponsored by the CAIA Association®, a not-for-profit and independent organisation established in 2002 with the support of industry leaders, the Chartered Alternative Investment AnalystSM designation is the only global educational standard for the industry. The CAIASM charter certifies an individual’s mastery of the concepts, tools and practices essential for managing traditional and modern alternative vehicles (real estate, private equity, commodities, as well as hedge funds and managed futures) and promotes adherence to high standards of professional conduct.

Candidates must pass two levels of exams and have at least one year of financial experience. Level I embraces traditional investment and fundamentals of alternatives, while Level II covers each alternative class in more depth and deals with advanced topics in alternatives such as risk management, securitisation, structured products, regulation & taxation. Both levels incorporate a sound treatment of ethics and professional conduct. These two exams can be taken six months apart offering candidates a rapid return on investment. Programme graduates explain that they have developed a bird’s eye view of the industry, have been able to cross-fertilise knowledge from the various alternative segments and enjoy the benefits of an independent certification of their skills.

In 2004, the Chartered Alternative Investment Analyst Association® selected EDHEC Business School as its exclusive provider of CAIASM exam preparatory courses for Europe. As such, we provide candidates with solutions to leverage their study efforts and allow them to take the tests with the best chance of success.

Our offering for the Fall 2006 CAIASM examinations is centred on intensive review seminars organised in London, Zurich and Paris. Designed and delivered by experienced professionals, these seminars provide candidates with important insights for the exams. Participants in our seminars receive study notes which summarise all CAIASM readings plus hundreds of exam-type questions which help them to focus their review efforts. We also distribute self-study products.

What is the profile of these CAIASM candidates?

Frédéric Ducoulombier: CAIASM candidates come from 48 countries and include industry newcomers seeking to establish a solid understanding of alternative investments, traditional asset managers wishing to explore alternatives as an additional class for their portfolios, and seasoned alternative professionals who want to assimilate the latest research advances or understand the alternative vehicles they have not been covering.

The programme appeals to a remarkable variety of professionals and institutions. Functions represented include fund managers and directors; analysts, consultants and research heads; product, marketing and sales managers; as well as administrators, lawyers and compliance personnel. CAIASM candidates represent hedge funds and CTAs, private equity firms, financial advisors, funds of funds and asset managers, private banks, and leading institutional investors. Real estate firms are also present but have been slower to adopt the designation.

Can the rapid growth of the programme be sustained?

Frédéric Ducoulombier: Registrations more than doubled in 2005 and continue to grow by 50% every semester. The 1,000 mark was reached at the last exam session which attracted 1,200 candidates worldwide, I believe this growth is sustainable for several reasons: First and foremost, while institutions initially supported individual candidates, sponsorship of group registrations has progressed dramatically. We have seen large alternative managers such as EIM or Lyxor sign up multiple employees for our preparation courses and boutiques sending whole teams through the programme. There is a small but growing list of alternative specialists who make it a requirement for their professionals to earn the CAIASM designation, while many more organisations, such as Citigroup or CSFB, use the CAIASM curriculum as an essential part of their alternative investment education.

While guaranteeing a high level of competence to increasingly demanding investors and getting ahead of competitors are the main drivers of institutional support, the decision by the S.E.C. in the U.S. to integrate the CAIA Association® charter programme into their internal hedge fund training system should provide additional impetus for growth.

Last but not least, a critical mass has been achieved. The number of Chartered Alternative Investment AnalystsSM worldwide will break the 500 mark this month and local CAIASM chapters are strengthening in financial centres around the globe which means CAIA Association® members will be more visible and more effective at serving the investment community. Increased scale also allows the association to step up efforts to advocate high professional standards and publicise the designation. Among other actions planned for 2006, the association will host informational events in Zurich6, London, New York, Toronto and Singapore. In this context, we are delighted to announce that our exclusive course provider status for Europe has been confirmed for another two years by the CAIA Association® and that we have partnered with Instituto de Estudios Bursátiles to better serve the Spanish investment community as we expect interest in alternatives will surge following the creation of a legal framework for hedge funds in November 2005.

The EDHEC Risk and Asset Management Research Centre is perhaps best known for its hedge fund expertise. 2005 has been a year of contrasts: while A.U.M. have boomed, returns have been lacklustre and funds of funds have been reported to have had a hard time; do you have ideas - and training - to offer for this new environment?

Frédéric Ducoulombier: Fuelled by institutional money, hedge funds have grown from a cottage industry catering to the needs of private wealth to a trillion dollar business in which over 8,000 managers compete for the attention of global investors.

While a number of industry commentators have been quick to link falling returns to industrialisation through the capacity effect theory (which hypothesises that inflows into alternative classes have made markets too efficient and reduced alpha opportunities), EDHEC research has documented that this was a fallacy and that picking up risk premia for alternative risks – which are cyclical and were depressed in 2005 – drives returns.

Evidence7 that the average fund performance is explained mainly by passive exposure to risk factors as minor pure-alpha benefits from asset picking are offset by poor beta timing means that a disciplined approach to optimising the beta benefits of hedge funds is called for. It also suggests that fund managers who want to protect against the threat of low-fee passive vehicles need to implement the latest techniques to deliver outperformance through improved selection, dynamic alpha and beta management and active style allocation.

Hand in hand with the industrialisation of the hedge fund space come stricter requirements in terms of risk management processes and the need to back value creation claims with quantitative reports on relative performance and factor exposure.

Since hedge funds can no longer be considered in isolation, successful players will be those who are able to advise institutional investors on how to optimally incorporate alternative complements into their core and satellite portfolios.

While most hedge fund programmes on the market deal with fundamentals and the big picture, we help professionals adapt to this new environment by offering an advanced course aimed at developing practical skills.

Designed and delivered by François-Serge Lhabitant, associate professor at EDHEC Business School and senior advisor to Kedge Capital Partners and Lionel Martellini, scientific director of our research centre, this two-day seminar equips participants with a workable knowledge of the state-of-the-art techniques for analysing the performance and risks of alternative investments, unleashing new sources of value, and optimising hedge fund benefits both at the fund level and for end-investors. The course covers such issues as the optimal design of hedge fund portfolios, the use of alternative investments in LDI, portable alpha and portable beta strategies, and the extension to the Black-Litterman approach to hedge fund style allocation decisions.

Presented in a highly accessible manner and drawing upon our latest research results, the seminar appeals to fund of hedge funds managers, to investment officers and administrators working for institutional investors, and to consultants and key account representatives advising high net worth investors and institutions on hedge fund matters.

Frédéric Ducoulombier, CAIASM is an associate professor at EDHEC Business School and the Director of EDHEC Alternative Investment Education.



References

1 According to HedgeFund Intelligence survey data as reported in The Times on March 16, 2006

2 According to data released by NVCA & Thomson Venture Economics on January 17, 2006

3 EDHEC European Alternative Diversification Practices Survey, December 2005

4 Advisers who allow withdrawals within two years of an investor’s investment and have over 14 clients residing in the U.S. need to register with the S.E.C. under the amended 1940 Investment Advisers Act – U.S. advisers with assets of under USD30 million are exempt.

5 On January 31, 2006, the EU Commission appointed experts to examine whether possible internal market failures are having a detrimental and significant impact on the cross-border development of the alternative investment industry. The Expert Group on Alternative Investment Funds will document and analyse the current organisation of the private equity and hedge fund businesses. It will examine “whether operators in these asset classes are confronted with significant difficulties in organising their activities in the European marketplace, and explore whether these issues warrant attention from EU policy-makers.” (IP/06/96)

6 Club Indochine, Zurich; 4 May 2006, 19:00-21:00 – To Register

7 The Right Place for Alternative Betas in Hedge Fund Performance: an Answer to the Capacity Effect Fantasy, Géhin and Vaissié, Edhec Risk and Asset Management Research Centre, June 2005