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Jérôme Teiletche: «Replicators are complementary to hedge funds. They are also more liquid and transparent than investable indices »

Lombard Odier has been among the first asset management firms to launch investment vehicles which replicate hedge funds. We carry out an assessment with Jérôme Teiletche, the head of systematic investment strategies….

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Next Finance: You have launched the fund called LO Funds – Alternative Beta which seeks to replicate hedge fund strategies. What assessment do you make on this type of fund and how did they behave during the crisis?

Jérôme Teiletche: The launch of the first hedge fund replicators was done back in 2007. At this time, some investors were sceptical of the concept. According to them, it was not possible to replicate the highly dynamic strategies applied by hedge fund managers. The crisis has abated those doubts. Replicates have, first of all, done a good job by displaying a good correlation level. They have also differentiated themselves during the worst time of the crisis through their liquidity. Regardless of market conditions, they have continued to serve their clients.

What advantage would an investor have by putting money in this type of fund instead of investing directly in a hedge fund or even in an ETF replicating a hedge fund strategy (these products will soon be launched by DB-X- Trackers)?

The first important element is not to consider replicates such as LO Funds – Alternative Beta as a direct competitor of traditional hedge funds. It is a liquid complement to a traditional hedge fund portfolio. In these conditions, any comparison between them is not relevant.

Then, regarding “investable” indices, these vehicles do not go as far as synthetic replication in terms of liquidity and transparency. They also focus on a narrower spectrum whereas replicates cover a broader range comprised notably of closed hedge funds

In conclusion, replicates are complementary to traditional hedge funds as well as more liquid and transparent than “investable” indices. These arguments are convincing a greater number of investors.

Investable indices focus on a narrower spectrum whereas replicators cover a broader range comprised notably of closed hedge funds.
Jérôme Teiletche

You are the head of systematic strategies at Lombard Odier. One of the main complaints targeted towards this asset management style is the lack of transparency. Systematic funds are often likened to “black boxes”. How do you take on this transparency challenge from investors?

From a general point of view, quantitative management suffers from a perception problem. It is viewed negatively because of the fear stemming from mathematics and statistics. This is odd since a human brain is certainly closer to a black box than an algorithm.

If you take, for example, an investment spectrum comprising of 1000 securities, systematic management has the ability, through its analytical tools (PE analysis, dividend yield, free cash-flow) to better apprehend such a spectrum. In an opposite fashion, discretionary management will offer a sharper analysis but on a narrower spectrum.

Regarding systematic funds, a distinction can be made between two types of approach: the “high frequency trading” which is based on signal treatment (statistical arbitrage) and the “fundamentals” which try to bring a systematic order to the decision rules which are based on these fundamental models (share valuation, economic cycle analysis…).

At Lombard Odier, we favour the second approach. Regarding the framework surrounding LO Funds – Alternative Beta, our job consists in understanding the structure of returns gained by hedge funds in order to replicate their bets. The greater the number of hedge funds, the greater the demonstration of correlation until a certain ceiling is reached (30 – 50 hedge funds). Concretely speaking, the LO Funds – Alternative Beta fund is totally transparent in its composition (long and short positions on the securities involved) and in the description of its underlying model.

From a technical point of view, what are the criteria that you base yourself on in order to determine whether a strategic systematic is “performing” against its underlying market? Also, what are the criteria that are used to put back into question a strategy that performed well in the past but is now proving to be unprofitable?

“Back tests” enable us to analyze the performance of a model in different market conditions. The behaviour of a strategy when compared to the back test results enables the value of a model to be judged. In any case, decision rules will evolve over time

From a general point of view, quantitative management suffers from a perception problem. It is viewed negatively because of the fear stemming from mathematics and statistics. This is odd since a human brain is certainly closer to a black box than an algorithm
Jérôme Teiletche

On a daily basis, what are the biggest difficulties against which are confronted all systematic asset managers? The apprehension of slippage costs on a particular strategy before it is implemented? Timing management? The setting up of an efficient IT structure?

It is necessary to make a clear distinction among the asset managers depending on the type of strategy involved. Those who adopt a “high frequency approach” act on very short term horizons. They carry out algorithmic trading where speed execution is essential. “Fundamental” managers on the other hand have a longer investment horizon. This leads them to be less concerned about timing management even if they remain sensitive to the cost of the transaction. In any case, the development of a platform and the optimisation of data management are essential.

What types of investors can be interested by systematic strategy funds?

Our firm considers systematic strategies as a complementary approach to hedge funds or funds of funds. They are relevant to both private and institutional portfolios. They allow for the management of a broader environment in a more determined fashion.

What are the systematic funds launched by Lombard Odier?

Lombard Odier has a complete array of systematic funds. These funds invest in global share environments or more specialized ones based on sector and geography. They also invest in bond markets and in “multi asset” management all of which lead to replication. They base themselves on quantitative models set up by our systematic asset management strategy teams through collaboration with other internal competences (hedge fund teams for example). Globally, quantitative management is present among the approaches followed by our firm but it is not the only one. It is meant to be efficient within an enhanced management “framework”.

Next Finance , June 2010

Article also available in : English EN | français FR

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