www.the-actuary.org.ukhas served as a good base for understanding many of the techniques that hedge funds are using to extract value from investment markets. While it is likely in any particular sub-strategy that the hedge fund manager is going to have far more specialist knowledge and experience than you will have as a fund-of-funds manager, you have got to be able to grasp the key concepts behind their approach quickly. In a 64257 xed income and derivative-related setting, a good understanding of cash64258 ow modelling and of 64257 nancial economics and derivatives is necessary. In some strategies, a more traditional actuarial analysis comes into play. As an example, some hedge funds focus on investing in asset-backed securities such as pools of mortgages. These are typically split into tranches in collateralised debt obligation structures (CDOs), where different portions of the risk and cash64258 ows are allocated to different investors. Understanding the cash64258 ows to a particular tranche under a variety of pre-payment and default scenarios is akin to a traditional cash64258 ow modelling and scenario analysis exercise that a life company might do to understand the pro64257 tability of a speci64257 c sector of existing business.How do you then assess the investment opportunity?Of course there is much more to making an investment than just understanding the maths behind the investment strategy 8212 that simply forms the basis for a common understanding to begin assessing the opportunity. One then needs to spend time understanding the reasons why markets may be inef64257 cient in pricing these securities and what is creating an 8216arbitrage8217 opportunity that is repeatable and exploitable.In the case of asset-backed securities, the regulatory regime of many institutions such as pension funds, insurance companies and banks, requires them to invest in securities rated as 8216investment grade8217, resulting in excessive demand for investment grade-rated debt. In turn, the credit rating agencies have developed fairly complex models to rate the various tranches of asset-backed securities and CDOs. The excessive demand for investment grade-related tranches from such investors can result in distortions that push a disproportionate part of the economic value in the structure towards the more risky 8216unrated8217 and non-investment grade portions of the debt. Understanding the regulatory regimes for pensions, life insurance companies and banks assists in understanding the creation of these anomalies. At the same time, it is necessary to apply risk assessment techniques because if hedge funds are investing in the higher-risk parts of these structures, they are, by de64257 nition, more likely to be exposed to losses, so one has to ask how they assess and hedge these risks.All of this, of course, is still part of understanding the investment process and doesn8217t even begin to address the even more important soft issues of assessing the individuals managing the hedge fund, the operational and legal issues and so forth. Which other parties have you typically worked with when assessing investment opportunities?Other investment managers and analysts with different backgrounds bring a new perspective. Some have had direct experience in trading at investment banks or working at hedge funds, which brings an important viewpoint on market technicalities and dynamics.I have also worked with auditors and lawyers who are involved in looking through all of the documentation and assessing the operational and 64257 nancial controls of a fund before proceeding with an investment. What lessons can the actuarial and investment communities learn from each other?From my perspective as an actuary, there is a lot of terminology and jargon in each sector of the market with which you have to familiarise yourself quickly. To communicate effectively with traders you need to be able to speak their language. Concepts are often similar or analogous to ones in other investment or actuarial areas but understanding 8216trader-speak8217 can be a steep learning curve in every different investment area.It8217s also important to appreciate how easily regulation and reserving standards have the ability to create economic distortions within markets that can then be exploited by sophisticated 64257 nancial players.Differences between traditional actuarial and 64257 nancial economic models can create arbitrage opportunities. There is no such thing as a perfectly ef64257 cient market, yet neither (or very seldom) is there a risk-free arbitrage.How might actuaries generally 64257 t into the alternative investment world?I would say that the transition is possible but it can be challenging. There is no automatic AGBInvestment actuariesA new way of thinking Tracey Brown talks to Keith Guthrie, head of investment management at Cardano UK, about the role that actuaries can play in the investment arenaKeith Guthrie is head of investment management at Cardano UK32 March 2008tranche under a variety of pre-payment and default scenarios is akin to a traditional cash64258 ow modelling and scenario analysis exercise that a life company might do to understand the pro64257 tability of a speci64257 c sector of existing business.How do you then assess the investment opportunity?Of course there is much more to making an investment than just understanding the maths behind the investment strategy 8212 that simply forms the basis for a common understanding to begin assessing the opportunity. One then needs to spend time understanding the reasons why markets may be inef64257 cient in pricing these securities and what is creating an 8216arbitrage8217 opportunity that is repeatable and exploitable.In the case of asset-backed securities, the regulatory regime of many institutions such as pension funds, insurance companies and banks, requires them to invest in securities rated as 8216investment grade8217, resulting in excessive demand for investment grade-rated debt. In turn, the credit rating agencies have developed fairly complex models to rate the various tranches of asset-backed securities and CDOs. The excessive demand for investment grade-related tranches from such investors can result in distortions that push a disproportionate What is your background in the investment 64257 eld?I have been managing fund-of-funds or multi-manager portfolios for the past eight years. Prior to that, I worked for a banking and life assurance group in South Africa in a variety of corporate actuarial roles from stochastic modelling and valuations to business strategy. Do you have an example of where actuarial thinking and techniques might be applied in an investment management role?An actuarial background 032_033_Actuary_Guthrie_0308.ind32 3219/2/08 12:36:51
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