Institutional Investor's Alpha Magazine - October 2008 - (Page 26)

André Perold It’s an upbeat point of view emblematic of Perold’s long career. Fellow Harvard professor Robert Merton, the 1997 Nobel Prize winner in economic sciences and a former partner at Long-Term Capital Management, which had its dramatic demise in 1998, admires the breadth of Perold’s research. “He’s deeply engaged in problems that are interesting,” Merton says. “André brings a clarity of thought and rigor to the analysis.” Perold’s dual presence in academia and the day-to-day markets is crucial, says William Spitz, a former CIO at Vanderbilt University in Nashville who taught alongside Perold in executive education programs at Harvard for many years. “André is one of the few people I know who has very strong academic credentials but is also very plugged into the real world,” notes Spitz, who co-authored two Harvard market case studies with Perold and served at HighVista and how the hedge fund industry may look in the future. Alpha: What scares you most about the unfolding ﬁnancial drama? Perold: First, the staggering loss in wealth. World equity market capitalizations alone have fallen nearly $30 trillion, and the effects of this wealth loss will be signiﬁcant and lasting. Second, the domino effects and systemic failure we have seen in just about every corner of the ﬁnancial system. We are clearly in desperate need of infrastructural innovation. Are you worried about how this ﬁnancial crisis will affect hedge funds? “Managers who can no longer rely as much on leverage or short-selling will have to reaffirm their value proposition.” — ANDRÉ PEROLD The generic hedge fund model has been severely challenged — as has the infrastructure that supports hedge funds. Take the notion of leverage, for example. When leveraged, you may be forced to sell simply to maintain your leverage ratio after suffering a loss, or you may be forced to sell because the terms and availability of your ﬁnancing have changed, or you may be forced to unwind positions because the costs and risks of maintaining short positions have increased. At the same time you may have to reduce your exposures to meet client redemptions, and you may face the added hardship of frozen or nonrecoverable positions held at a prime broker that went bankrupt. It is not a good business model when you can’t depend on ﬁnancing, client capital or the underlying infrastructure. Describe the hedge fund of the future. with him on the board of Wilton, Connecticut–based Commonfund — a nonproﬁt investment manager serving the endowment and foundation community — for a decade, until 2001. According to an investor in the ﬁrm, HighVista’s return for the latest endowment year, ended June 30, was 7.7 percent after fees. Its gross return of 9.6 percent for the same period topped the 8.6 percent performance of Harvard’s endowment fund as well as Yale’s 4.5 percent. HighVista reported a 6.2 percent annualized return for the three-year period ended September 30. Perold’s eight-page bibliography includes research collaborations with such luminaries of ﬁnance as Nobel Prize–winning economists William Sharpe, the creator of the Sharpe ratio, and Harry Markowitz, the father of modern portfolio theory. In addition to his many research papers, Perold co-authored two books, The Global Financial System: A Functional Perspective and Cases in Financial Engineering: Applied Studies of Financial Innovation, both published in 1995. After graduating from the University of Witwatersrand in his native Johannesburg in 1974 with a degree in applied mathematics and statistics, Perold earned a Ph.D. at Stanford University. After a postdoctoral year at IBM Corp.’s T.J. Watson Research Center in Yorktown Heights, New York, he took a professorship at Harvard. In early October, Alpha Senior Writer Frances Denmark spoke with Perold about his investment approach 26 • INSTITUTIONAL INVESTOR’S ALPHA • OCTOBER 2008 The funds with the best chance of survival will be those that structure their businesses to be compatible with their investment approaches. Longer lock-ups, akin to a private equity model, will reduce the potential universe of investors but will address the issue of capital stability. At a fundamental level managers who can no longer rely as much on leverage or short-selling will have to reafﬁrm their value proposition. They may need to run lower-leverage, longer-biased funds, which might affect their ability to earn returns. They may still be able to outperform but might need more equity to do so. There will be less alpha per dollar of investor equity, and clients may walk or demand lower fees. Long-short funds that become essentially long-only will have to change the benchmarks relative to which they receive their carry. Investors will say, “I’ll pay you for returns in excess of the S&P 500 but not over zero.” Clients have long been concerned about paying a carry on beta, and these changes will only accentuate those concerns. What if hedge funds were required to publicly disclose their short positions? For many the investment world would become quite inhospitable. The capital markets are extremely competitive, and protecting your proprietary insights is crucial to your ability to outperform. It’s also much riskier to sell short

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - October 2008

Institutional Investor's Alpha Magazine - October 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Process of Evolution The Good Guys: Israel's Champion Interview: Fast Lessons for Hard Times Cover Story: Industry Under Siege The New Hedge Fund Economics Good-Bye, Easy Money Caging the Shorts Strategies: Bottom Fishing Profile: Cult of Personalities Research Center: Alpha Awards: Eye of the Storm Alpha Bytes: Funneling the Chatter Unhedged: Commentary: Attention, Hedge Fund Shoppers

Institutional Investor's Alpha Magazine - October 2008

For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.