Hedge Fund Monthly
| An Interview with Laurent
Favre, Founder and CEO of AlternativeSoft LLC
| AlternativeSoft LLC |
| November 2004|
With the increase in the amount of hedge funds under management
as well as the high demand for investors in this type of investment,
a new company is launching itself into constructing and selling
an IT platform designed to construct traditional portfolios
and funds of hedge funds: HFOptimizer platform.
What is behind the concept of HFOptimizer's platform?
The concept was born when my thesis won an award from
a Swiss bank for the best university project of 2000.
The concept is based on minimizing extreme negative returns.
In 2001 and 2002, I developed this model in Visual Basic
purely for academic reasons. In 2002, one of my articles,
"Modified Value-at-Risk Optimisation with Hedge Funds"
achieved real recognition. In 2003, I was invited to conferences
to present my idea on extreme risks. In 2004, the EDHEC
Business School stressed that optimization using Modified
Value-at-Risk was a useful technique for reducing extreme
risks. In 2003 and 2004, this Visual Basic model was used
by UBS Wealth Management to help construct its funds of
hedge funds. Realizing that the bank's internal demand
for this kind of model was high, I decided to found AlternativeSoft
LLC in June 2004. The objective was to offer investors
an IT platform that combines the portfolio construction
methods of a large Swiss bank and the latest academic
At this point, I had to recruit motivated programmers
who were quick and had cutting-edge knowledge of statistics,
whom I found in Russia. In terms of the academic model
that makes our platform attractive, they are derived from
working papers (i.e. Conditional VaR minimization), books
on hedge funds (i.e. The Sharpe-Based Style Analysis)
and our own research (i.e. Four Moment CAPM pricing).
The greatest challenge was creating a fast optimization
algorithm that resolved nonlinear functions, extreme risk
functions. We obtained rapid and precise calculations
even for portfolios with 200 assets.
I hope the combination of these three factors-quick programmers,
academic models and fast calculations-are going to ensure
the success of our platform. To increase the chances of
selling our IT platform, we have surrounded ourselves
with financial advisors.
Every bank has its own system of constructing portfolios
or funds of hedge funds. One of our objectives is to free
our clients from systematically using Excel , Matlab ,
Solver , E-views , etc. to construct their portfolios.
All in one platform, we have put a precise optimization
tool, a model designed to select funds and construct portfolios
and a tactical asset allocation model in order to save
time and generate superior performance.
- What risk management services does AlternativeSoft
LLC offers its clientele?
Currently, AlternativeSoft LLC is offering its IT platform
to banks and financial institutions. Our clients want
to take advantage of the latest quantitative academic
models for choosing hedge funds, constructing portfolios
and forecasting index returns.
We believe that consulting in forecasting hedge fund index
returns has a bright future, the same future as traditional
tactical allocation has had for 10 years. Given that it
is possible to forecast monthly returns on hedge fund
indices (see, for example, Amenc, El-Bied, Martellini,
Evidence of Predictability in Hedge Fund Returns and Multi-Style
Multi-Class Tactical Style Allocation Decisions, 2002),
investors will be tempted at some point to utilize tactical
allocation of hedge fund styles. Investors will have the
choice between purchasing our platform or using our consulting
services to make forecasts. This consulting service offered
by AlternativeSoft LLC should be very successful in 2005.
As a bank or as a fund of funds, why should I purchase
or switch to your platform?
Our platform is interesting for three main reasons. The
first reason is that our platform will allow you to understand
the effects of extreme risk on the optimal wealth of a
portfolio. Imagine that average variance isn't the right
measure for constructing portfolios, including hedge funds-your
company would take a high operational risk. Secondly,
our platform will be useful to you if you think that quantitative
analysis is as important as qualitative analysis in choosing
hedge funds and constructing funds of hedge funds. Thirdly,
you can use our platform on your laptop while meeting
with a private client or a pension fund because we have
built a platform that is easy to use.
Currently, our clients are funds of hedge funds in the
process of growing that do not yet have the infrastructure
to hire several hedge fund analysts, funds of hedge funds
managed by academics who think that quantitative analysis
is as important as qualitative, or by banks that are branching
into managing funds of hedge funds. This shows that our
platform is useful to institutions without a broad infrastructure
that want rapid growth without having to hire a lot of
- How has risk management evolved and how do you see
the changing in the future?
As aforementioned, I think that hedge fund risk and
funds of hedge funds will increasingly be measured by
using extreme measures like Value-at-Risk, MVaR, CVaR,
Omega or skewness. In the future, someone who invests
in hedge funds and structured products should focus more
on these extreme measures than on volatility.
- How can technology help performance?
Like in many hedge funds like CTA strategies, fixed-income
arbitrage or statistical arbitrage, technology helps manage
a faster decision-making process. I think this is also
the case in constructing funds of hedge funds where it
is possible to extract from historic returns, the default
probabilities. In 2005, we will attempt to integrate in
our platform a model that would give probabilities of
hedge fund manager fraud. We will add as well a hedge
fund rating in our platform. This will partly replace
lengthy due diligence processes.
How can clients benefit from using your platform
as compared to traditional platforms available on the
In our platform, the client benefits from the latest
academic models for choosing and constructing hedge funds
and forecasting returns. The platform is dedicated almost
exclusively to hedge fund investment. Thanks to this platform,
the user of our platform obtains added value by quantitatively
justifying his/her selection, by constructing funds of
hedge funds with little negative extreme risk and by improving
returns on his/her fund with tactical allocation.
The differences between our platform and the other platforms
are the following. Our platform includes normal and non-normal
portfolio simulation. To construct portfolios and fund
of funds, our optimization minimizes the probabilities
of extreme negative returns. Our platform exhibits the
portfolio shortfall risk (i.e. the probability to be,
in the future, below a certain target return). Our platform
is doing portfolio stress testing with respect to the
selected desired benchmark. Our platform ranks the hedge
funds based on their styles and extracts the hedge fund's
alpha. Finally, our platform forecasts the hedge fund,
stock and bond indices returns by using an economic model.
Our competitive edge is our speed in setting up new academic
models. In August 2004, a Finnish pension fund asked us
about correcting hedge fund returns for autocorrelation,
which we did a month later in the September 2004 release.
- What is the most important for you: manager selection
or asset allocation?
In the past, manager selection was the main activity
in a fund of hedge fund. In the future, with the advent
of platforms like Lyxor, asset allocation or style selection
is going to gain importance in the investment process
of a fund of hedge fund. With the growth in the number
of investors and the strong demand for diversified funds,
those with a good diversification technique and a tool
for forecasting returns will outperform those only concerned
with manager selection. This phenomenon will be just like
what happened to traditional portfolios, where asset allocation
(market selection or sector selection) contributes more
to performance than stock selection.
- How do you see the hedge fund market developing over
the next few years?
In 2005, I imagine an exponential demand for funds of
hedge funds from pension funds, but also from retail clients.
The number of hedge funds will continue to increase. Average
returns should decrease in 2005 and 2006, given the growing
number of new hedge funds. A consolidation will occur
in 2006 in order to take advantage of economies of scale.
Like after all consolidations, average returns on hedge
funds should rise again in 2007. It is important to see
that hedge fund returns are linked to inefficiencies that
people try to capture.
- How will your platform evolve to address those issues?
AlternativeSoft LLC and its HFOptimizer platform will
continue to develop in 2005. We hope to hire new collaborators.
We will integrate a new optimization model that will combine
hedge funds with traditional portfolios. We will integrate
optimization using the Omega coefficient. We will improve
the hedge fund style selection model so our clients can
generate returns greater than the indices. Our clients
can look forward to a new version of the platform every
This interview first appeared in Alternative Market Briefing
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