Recently, we had the opportunity to speak with Laurent Favre, CEO of Alternative Soft, a quantitative hedge fund software solution for portfolio construction, funds selection and tactical asset allocation using hedge fund strategies.
In the interview we cover changes in the hedge fund industry, the outlook for the next few years, and evaluating hedge fund technology providers.
Here is a summary of that interview (with some edits). You can also listen to the entire interview with Laurent Favre.
HFMA: Before we jump into the interview, maybe you could tell us just a little bit about your background and how you ended up where you are today.
Favre: Okay. So what about my background, I have studied several years at university and several Masters, and then I decided to go and work in a large bank, which was a Swiss bank in Switzerland, where I worked four years. I was responsible for doing tactical asset allocation long only, where I learned a lot. And then after four years I decided to switch a bit due to reason incompatibility between the bank and myself. I looked for a job in the hedge fund space, which I found in London, which was in 2005. But at that time I had launched a small software product that I was able to sell to the largest fund of fund in Switzerland.
So, I had been hired in London in a large bank, running a fund of fund, where I was working for them 50-percent and running as well my company 50-percent. I did that during four years in London, which was excellent. And then during the crisis, in 2008 and 2009, then the bank restructured a bit, so they fired some big bosses and other analysts and myself as well. And then I worked 100-percent for my company since June 2010. And now I’m really happy to do that, because my company is growing at a fast speed.
HFMA: The dedication to the company is really what made it take off?
Favre: Yes. I have always helped people when they helped me. The bank in the U.K., they help me a lot by allowing me to work 50-percent for them, where I was responsible for the full investment process, and 50-percent for my company, which was at that time small. We were around 8 people at the time and now we are 15.
HFMA: So tell us a little bit about AlternativeSoft. What do you do? What does the software do and who are your target clients?
Favre: Okay, the answer is easy. We sell just the software for fund of hedge fund and banks investing in hedge funds, mutual funds, and ATF. Our software is different because it focuses on extreme downside risks. Second, our software is easy to use. Even though you are a big boss in a big bank, you open our software and you know what to do.
HFMA: Okay. Let’s switch gears here and let’s talk about some things that are happening in this industry, and specifically what are some of the changes that you’re seeing in the hedge fund industry? And what’s your outlook here going forward?
Favre: First what I see is a change. I mean there is nothing clever here because you just need to open your eyes. What we have seen in our investor client needs is more transparency in the hedge funds. Second is lower fees for the hedge funds. Third is less leverage. Fourth is more clients are investing directly in hedge funds. Before they were investing in fund of funds; now they come to us and say, “Hey, we learned that you allow us to invest – or your software allows us to invest in hedge funds. How does it work?” So these guys are coming directly to us. And the last point is higher liquidity required in hedge funds.
So these are the changes you can see that everybody who is reading a paper or you can see on Bloomberg and CNBC. Now some of these changes will not stay in the future. Because some are an overreaction.
For example, all this high liquidity with this less leverage, this is just overreaction. It will come back, perhaps not as before.
HFMA: So let’s talk about that. You’re right, you can pick up The Journal or any one of the financial magazines and read all about these things and of course the buzz about the additional regulation being levied on the hedge funds. But maybe an overreaction. So what do you see going forward?
Favre: Excellent question. Why? Because it’s important to know that it’s an overreaction. I will give you my outlook for the next three years. I’m not sure that a lot of guys giving next three years, so just my view.
But what is important to know is that given all the debt we have everywhere in the world except in Asian countries and Germany, and with low interest rates, it’s an excellent time to invest in hedge funds. This is the first point. Because they are able to benefit from inefficiency.
So what we see next three years is two categories of hedge funds will emerge, which we see already. The first category is a category which will look like mutual fund. In this category we will put what we have today, these 130 and 30, these absolute funds. And who will invest in them? Pension funds and banks. These categories of hedge funds will have lower fees and it will be possible to do large investment.
There is a second category. This category will be for fund of hedge funds. There will be less liquidity. The hedge fund will be smaller. They will be opaque. They will have higher return and they will have lower correlation to equity than the first category.
I gave you two categories and this differentiation will take time. Why? Because it will take 12 months to clean all that, to understand what is the next business model.
HFMA: It’s going to take some time just to sort through the new hedge fund market that we have and the changes that you mentioned earlier. Right? There’s the ability to report at a higher level of transparency, managing the fact that you’ve got different liquidity requirements. All of those things from an operational standpoint have to happen first, and I think as firms figure that out, then they’ll be looking at longer-term – what’s the strategy? How are we going to grow the fund? How are we going to attract new investors? You know, what’s our differentiation?
Favre: Exactly the point, differentiation. If you are running a shop now, whatever, it’s a small shop or bank. What do you offer to invest in? If you offer fund of fund with UCITS, tell me, what do you offer me? A bit liquidity, why do you offer me that? Differentiation, it is a business strategy.
HFMA: When somebody is looking at, for instance, your software or any piece of technology for their business, what should they be looking at? What are the things that they should be considering when they’re evaluating technology providers for their fund?
Favre: First I would say this is not difficult. The first question is does the software answer all my needs? Okay, yes, so I save the first one. Now the price, what is the price? Is it $100,000 USD or is it $10,000 USD software?
The third one is when I select the technology provider, what is this technology provider’s annual profit? Why? Because we have to be sure that the guy is in the business in three years. But if the guy does not know whether UCITS will survive or whether liquid hedge funds will survive, the technology provider does not know where to direct his company, where to develop his software. So we have to be sure that this technology provider has enough annual profit.
The fourth one is client references. It’s always good to be sure that this technology provider has some big clients. The fifth is what is the speed in delivering new models? For example, if suddenly UCITS are coming on the market, is the case in three months, there are some database which are providing special data with UCITS funds. Now, the question is how long will it take for this technology provider to update? If it’s two years, clearly it does not work; you should not go with him. If it’s two months you should go with him.
And the last one is user-friendliness. Because when you buy – I’ve seen a lot of times that a fund of funds buys software or technology, which can be simple or really complex. It should not be a burden, it should help you.
I’ve seen some fund of funds buying software, where one guy was working 100-percent of his time on the software, just to input data, nothing automated, and then nothing really was working, it was losing data. The question is user-friendliness.
HFMA: So, the idea there being if you’re going to make the investment, the only way you’re going to recoup the investment, you’re going to get an ROI, is to make sure that it’s being used as it was designed and on a regular basis.
Favre: Yes. Not only on a regular basis, but it should be easy to use.
HFMA: Well, Laurent, thank you. We appreciate you investing the time here with us. Any parting thoughts? Anything you’d like to say before we sign off here?
Favre: Yes, that the hedge fund industry will increase in the next three years according to my categories, category one and category two. They will not disappear.
HFMA: So, all the discussion of the additional pressures, those pressures are here, the market will adjust, and you’ll find funds that will thrive in the new market?
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