Alternative Investments - April 12, 2007

Interview with François-Serge Lhabitant

In this month's interview we speak to François-Serge Lhabitant, Associate Professor of Finance at EDHEC Business School and Chief Investment Officer at Kedge Capital, about his new book, Handbook of Hedge Funds, and current issues in the hedge fund industry and in academic research.

François-Serge Lhabitant

Your latest book, "Handbook of Hedge Funds," is a follow-up to your two previous books on the subject, "Hedge Funds: Quantitative Insights" and "Hedge Funds: Myths and Limits." Could you tell us a bit about the new material in this latest publication?

François-Serge Lhabitant: The Handbook of Hedge Funds should really be seen as a complete overview of where hedge funds are today. It contains a lot of new material. The regulatory aspects have been completely revisited. The chapters on strategies and historical performance have been considerably expanded. For instance, all hedge fund strategies are now illustrated by several trade examples, which I think is the easiest way to understand how hedge funds operate. Several new strategies are now covered, such as credit strategies, cross listing arbitrage, mutual fund arbitrage, index arbitrage, etc. There is also a complete description of the risk measures commonly used by hedge funds, as well as a discussion of the asset allocation with and without hedge funds, the various indices and databases, and a review of the various structured products on hedge funds. As summarized by one of my friends who reviewed the book before it went to press, “there is a lot to be learned there!”

How has the hedge fund world changed in the five years since you wrote "Hedge Funds: Myths and Limits"?

François-Serge Lhabitant: In some areas such as regulation, it is a complete new world. But more generally, there are much more hedge funds around and several new types of strategies – in particular in the area of capital structure arbitrage, credit and at the frontier of private equity. Academic research has also progressed, although there is still a long way to go.

At the EDHEC Asset Management Days in Geneva, you expressed considerable scepticism about hedge fund replication, which is a hot topic in the industry at the moment. Could you summarise your position for our readers?

François-Serge Lhabitant: In general, I think that hedge fund replication can only work for funds that have a lot of static beta. Call it “alternative beta”, “exotic beta”, or whatever you want, but the fact is that the approaches suggested by Goldman Sachs, Dow Jones, Merrill Lynch, or Andrew Lo are essentially trying to determine the risk exposures of hedge funds using rolling regressions or similar techniques, and then attempt to replicate them using simple instruments.

In the average hedge fund, there are probably a lot of these static risk exposures and replication will work well. But in the “best” hedge funds - the few ones I am typically looking for as an investor - what I pay for is proprietary strategies with skilled traders, robust risk management and technology, and constant capital reallocation towards the best opportunities. I am also buying the experience of a manager that has been going through crashes and knows what to do when liquidity dries out, his credit lines are pulled down and his level of margins revisited. This dynamic behaviour is very difficult to replicate and this is why I might agree to pay 2 and 20 and sometimes even much more. So, my view is that if a fund is replicable ex-ante month after month by a simple “automated” strategy, then I am not interested in this fund – its manager is essentially selling beta at the price of alpha. Note that this is probably the case of the majority of hedge funds and hedge fund indices today, so why not replicate them…

I find the approach suggested by Harry Kat (FundCreator) is more interesting. First, it is more general, as it aims to provide returns with predefined statistical properties and hedge fund replication is only one of its possible applications. Second, it does not attempt to generate the same month-to-month returns, just returns with the same statistical properties as a given fund or index. As a result, it is not really the kind of “replication” that investors are familiar with. It is rather a replication of the return distribution at the end of a given time horizon - a completely different concept. Will investors understand the model and buy it? And will the model deliver the expected results? The future will tell.

You will be conducting an Advanced Hedge Fund Investing seminar with Professor Lionel Martellini in London on June 28th and 29th next. Could you tell us briefly about the topics that you will be discussing?

François-Serge Lhabitant: This two day seminar is covering the state of the art techniques for analysing the performance and risks of alternative investments and optimising hedge fund benefits at the portfolio level. The topics covered will include the alpha and beta benefits of hedge funds, the use of quantitative tools for performance and risk analysis, the diversification of hedge fund portfolios and also the use of hedge funds in an asset/liability management perspective.

What are your research projects at the current time and for the next few months?

François-Serge Lhabitant: On the publication side, I am working on a new book titled “Global Asset Management”, which will present a buy side view of asset management – as opposed to the sell side view, which is the one we are all familiar with. The starting point of the book is the observation that portfolios run by successful investors are generally very different from portfolios offered by financial intermediaries. But I will not tell you more and you will have to read the book to get the conclusion!

About François-Serge Lhabitant

François-Serge Lhabitant is Associate Professor of Finance at EDHEC Business School and Chief Investment Officer at Kedge Capital.

Professor Lhabitant has substantial experience in risk management and alternative investments, as both a practitioner and an academic. Before joining Kedge Capital, he was a member of the senior management at the Union Bancaire Privée group (Geneva) and was in charge of the quantitative analysis and the management of dedicated hedge fund portfolios. Prior to that, Professor Lhabitant was a director at UBS Global Asset Management and responsible for the quantitative modelling of hedge fund portfolios.

Professor Lhabitant's research has been published in leading academic and practitioner journals and featured in major European and global business dailies. He contributes to AGEFI, the Swiss leading financial newspaper and is a regular speaker at top industry events.

Professor Lhabitant teaches alternative investments within EDHEC Business School’s MiM and MSc programmes. He is also a celebrated author of global bestsellers on alternative investments.

Professor Lhabitant holds graduate degrees in engineering, banking and finance and a PhD in Finance from the Ecole des Hautes Etudes Commerciales of the University of Lausanne.

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Hyperlinks in this document:
(1) http://www.edhec-risk.com/research_news/books/RISKBook.2007-01-12.2720
(2) http://www.edhec-risk.com/AIeducation/Hedge%20Fund%20Training/Advanced%20Hedge%20Fund%20Investing