Systeia Capital Management

John Bonnacolta talks to Jean-Louis Juchault and David Obert

John Bonnacolta
Originally published in the September 2006 issue

Almost every facet of the finance world is known more for Darwinian working environments than for the careful cultivation of talent. But nowhere has performance become as crucial as in the hedge fund world in recent years, and according to some has clouded what is really going on inside certain hedge fund houses. As everyone knows, past performance cannot predict future performance, yet the wall of money coming into funds has often chased the best performance first.

As hedge funds evolve, the business is changing. For one, hedge funds are becoming more of a robust, structured business. The cowboy images of star fund managers placing huge concentrated bets is also evolving, even if mythic names such as George Soros, Julian Robertson, and Paul Tudor Jones will continue to inspire the younger generations of managers.

Today the marginal capital flowing into funds is coming largely from institutions, which naturally have different demands than the original capital base of hedge fund investors, which was comprised of wealthy individuals. While such trends are cited ad nauseum by hedge fund players, analysts, industry watchers, and the popular press alike, some players have been quietly building an institutional business of alternative investing well before the term "hedge fund" was known to most outside small finance circles.

Systeia Capital Management is one such hedge fund company. Based in Paris, Systeia is trying to build a diversified fund complex with a robust offering of different individual pure strategies while retaining its familial sizeand culture, a culture already rare and quickly disappearing in a business that has adopted the adage: "You're only as good as your last trade."

Jean-Louis Juchault, (age 45), and David Obert, (age 44), are the co-founders of the group, and act as dual managers of 40 or so professionals, of which about 19 are charged with managing the company's eight different fund strategies with a total of assets under management over 1 billion US dollars (as of June 30).

But the pair have a long history in the hedge fund business, having been involved in the creation of BAREP Asset Management, part of Société Générale, back in 1990, and each boasting more than 15 years experience in hedge fund investing. Their team approach, careful cultivation of talent, and institutional structure might just be a model for other international players to follow during this period of transition in the business.

Antithesis of the top-heavy star system

From the company's inception in December 2000, Juchault and Obert decided that they would not manage any funds day-to-day. Rather, they serve as managers and coaches for a team of talented fund managers, some of whom have been with them for over 12 years – a lifetime in the hedge fund world.

"One of the strengths of Systeia is the durability of its teams – we are extremely stable, with teams that have been together over a decade," explains Juchault, a jurist by training.

Juchault, the CEO, handles more of the management aspect of the business, where Obert, the CIO, is more markets- focused.

Both Obert and Juchault often humorously remark that they function as a couple, which in French bears the connotation of a romantic relationship. "Everything we do we do together, in tandem – we've been together so long, and we really have complementary skill sets," Obert says.

The pair met in 1989 at Société Générale, then moved to the BAREP group upon its creation in 1990. "We have to be extremely close to the trading aspects of the business, but performance is secondary even though fundamental," says Obert, an engineer by training and former interest rate arbitrage trader at BAREP Asset Management, a wholly-owned subsidiary of Société Générale specialised in alternative asset management.

"From the very beginning, even at the creation of BAREP, we have followed the idea that we need to seek alternative strategies for institutional investors. But 'alternative' does not exist in and of itself – it's rather 'alternative' relative to something. And in targeting institutions early on, we knew we had to create a solid organisation that had a broad offering of funds and a stable infrastructure to meet investors' needs," says Juchault.

In essence, Juchault and Obert carried over much of the philosophy of BAREP to Systeia, creating "silos" of fund strategies, each independently managed but overseen by the co-founders. To date Systeia offers: Managed Futures, Equity Linked, Long/Short, Event Driven, Global Macro, Equity Quant, Alternative Risk Transfer (specialising in certain insurance derivative instruments), then a Multi-Strategy that allows client-tailored allocations across the range of its funds. Across these strategies, directional and relative value trades might be put on to varying degrees, according to the style of the individual manager. Also, while some of the funds are discretionary, others are systematic, which is, although rather rare in the hedge fund world, something that Obert believes is complementary and fits perfectly with the firm's philosophy.

"Even in systematic trading, the systems and models need to be constantly revisited, and when you change a rule, it's a discretionary decision. Likewise, even for a discretionary portfolio, the framework that we arrive at upfront with a manager is comprised of a rigid set of rules whereby limits, stop losses, and other metrics are clearly defined and recorded, which is not that dissimilar to a systematic approach," says Obert.

Obert and Juchault sit down with a manager in order to determine the framework of each strategy, then continually monitor their progress on an ongoing basis, something Juchault sees as crucial to the organisation.

"Hiring talent is not enough – you have to be able to retain talent. And retaining talent means allowing people to grow within the organisation," says Juchault. "The easiest model is simply to pay, but regardless of what you pay, someone will always be willing to pay your offer plus one – it's very destructive and short-term focused. Our people have found more than just money – they have found an equilibrium, an autonomy, an ability to share not only the wealth of the organisation but the responsibility, and I think that's why we have been so successful in retaining them."

Systeia is 78 percent owned by Crédit Agricole Asset Management, with the remainder owned by the co-founders and Systeia staff. Having a strong, well-funded strategic partner is typical in France, where the hedge fund market has been focused on institutions since its beginnings, something many observers say would transfer well to an international model.

And while many hedge fund managers talk about being long-term focused, Juchault and Obert practice what they preach, with 25 percent of their original investors still with them from the BAREP days, and a host of employees that reach back to these early days as well. For example, Joël Gross, who runs the managed futures fund, was with Juchault and Obert in 1990, Edouard Petitdidier, manager of the equity quant strategy, joined the pair in 1993, Fabien Dornier, manager of the Alternative Risk Transfer fund, which specialises in insurance and weather derivatives, joined them in 1999. "Anne-Sophie d'Andlau [co-manager of the event-driven fund] is one of the more recent additions, and she's been with us since 2001," notes Juchault.

But it's not only tenure which seems to count at Systeia, but mobility and growth. Laurent Benaroche recently took the helm of the firm's Global Macro strategy, launched in June 2006 with now US$89 million. Previously, Benaroche was head of Systeia's managed futures strategy, a quantitative, system-driven strategy – he had been building quantitative futures trading systems for most of his career. He was previously co-manager of the systematic funds group at BAREP, where he met Juchault and Obert in 1994.

"Laurent Benaroche decided that he wanted to evolve into a discretionary strategy, that he felt he had peaked on the quantitative side," says Juchault. "Where other players might see a quant guy, David and I said, 'Go for it.'"

As Obert notes, "It is wrong to think of discretionary and systematic trading as two mutually exclusive disciplines – having spent so much time thinking about how to construct quantitative models should feed well into a broad perspective and macro approach."

Built to survive, survive by adapting

Integral to Systeia's institutional culture is its emphasis on surviving, which in global markets can require adaptability. It is perhaps no surprise Obert and Juchault: "Hiring talent is not enough" that both managers are active competitors, with Juchault a long time participant in rally car racing (events such as the famous Dakar Rally, formerly the Paris-Dakar), and Obert a former rugby man.

"Vision in this business is much too short-term," says Juchault. "The conception in this business that your last performance is the most important is simply not true. The first question a hedge fund investor should ask is: 'Are you capable of surviving the next crisis?' 'Are you a survivor?'"

Juchault believes that hedge fund investing is first and foremost the analysis ofcredit risk, which institutions understand. But it is a slow transition. He and Obert believe that only after you have demonstrated that you have the infrastructure and the systems in place can you even attempt to speak about providing consistent returns.

"Instead of asking whether a manager is capable of earning X percent, an investor should be trying to ensure FIRST that he doesn't lose his capital," says Juchault. He sees four parts comprised in this credit risk: (1) people; (2) strategic partner(s) and composition of the capital base; (3) internal organisation and control (including systems); and (4) administrative partners and controls.

The latter is something that Juchault believes is largely overlooked in the business. Systeia uses BNP Paribas as trustee, custodian, depositary bank, and valuation agent.

"The entire chain is controlled," Juchault notes. "This is what I call institutional quality – an investor needs to ask, 'At the end of the day, who's in charge?'"

Survivorship is thus not only about making the right trades, but also controlling the entire process of hedge fund investing.

"If you ask our managers if they've lived through the Latin America Crisis of 1994, the Asia Crisis of 1997, Russia in 1998, they will not only respond, 'I was there,' but 'I was there with Laurent [Benaroche], with David [Obert], with others.'"

Ironically, Systeia went live one week prior to Sep. 11, 2001, something that Juchault concedes as having been a harrowing, but quite effective, stress test on all of his systems. Perhaps, but sometimes you also need to adapt to changing market conditions and evolving investor demands. In 2004 Systeia began a fundamental examination and reengineering of its business in response to what it perceived as a paradigm shift in the markets.

"We have been in a rather peculiar period since Sep. 11, 2001," notes Obert. "The sustained period of low to zero real interest rates in the western world, coupled with the corporate restructurings that have taken place across so many industries and geographic regions, created a unique investment climate."

But a climate in which it became increasingly difficult to make money for investors. Investors, in turn, demanded riskier strategies in order to seek returns.

"We had to look at each of our portfolios and change the risk/reward profiles," says Juchault. "Before we were much more geared to lower volatility, but we realized we had to accept more volatility in these markets, that we could accept more leverage in certain strategies."

A good example of this might be the firm's managed futures strategy, which had been programmed under a trend-following model since its inception.

"Trend following was no longer viable as too many players were all in the same trades," notes Juchault. "We had to change the system to incorporate a contrarian element," explains Obert. "It took about 1 12 years to re-evaluate across all the strategies, but it's always a continually evolving process."

This is what Obert described earlier as being the discretionary element in systematic trading. In addition, Systeia also had to revisit the rules governing its discretionary portfolios.

"We have more volatility now across the board, but it's a much more effective product for our clients. You need to be proactive in this manner in order to retain good clients. It's not good enough to wait for them to express a change in demands – you have to initiate that dialogue with them," explains Juchault.

Of course, crises do not always have happy endings. More than any of the major headline crises of the past years, Obert concedes that last year's credit crisis in the high yield sector was the most painful for Systeia.

"No two crises happen in the same way, butI have rarely seen such an abrupt, violent move, without any fundamental change warranting it," Obert says.

Credit spreads had been narrowing consistently since about October 2002. But from mid-March to mid-May 2005, they blew out in sudden, violent moves before stabilising. The European high-yield bond market had seen issuance volumes race ahead, almost quadrupling in 2003 and rising another more than 40 percent in 2004. At the same time, pricing continued to test new lows, with Rémy Cointreau chalking up a new record at the start of 2005 when its €200 million issue priced at 5.2%, well below the initial guidance of 5.375%.

The Dow Jones iTraxx Crossover Index, which tracks the 25 most liquid European non-financial issues rated BBB/Baa3 or lower and on "Negative Outlook," touched 475bp in mid-May, up from 150bp at mid March 2005. And the widening had started well before S&P downgraded GM and Ford to junk status at the start of May, spooking the entire credit market. In late April, for example, Klockner, a German chemicals company, had to cut B3B- transaction from €350 million to €260 million.

"Our position in Fiat paper blew out from around 250-300 to 600, without any fundamental change in the company's financial position," explains Obert.

"But the broader market had been building to this, and when other funds began liquidating positions, some major prime brokers became threatened. It was all very structurally alarming."

Systeia's convertible fund finished June 2005 down 15 percent, but recovered positive by year-end. "We proved we could come back from it, which is what was important to investors," says Obert.

Autonomy – but with good coaching

The Systeia model calls for near complete autonomy in each of its "silo" strategies, but this doesn't mean that either Juchault or Obert are hands-off managers.

"I spend my entire day in front of trading screens," says Obert. "I watch macro variables across world markets, I see what our individual traders see, and I have screened lists of positions on a daily basis that I want to focus on, positions that I need to perhaps speak about with atrader."

Although Obert has the ability to intervene at the position level, to even cut a position, he says he would never think of actually doing so.

"Trading is psychology, and psychology is strengthened through dialogue. I might approach a trader to ask, 'Why do we have this position on?' 'What should we do with it?' In defending the position, in thinking through exactly what should be done with an individual position, the trader will at least come out of the dialogue with a stronger conviction one way or the other," says Obert.

Obert stopped trading a daily book in 1993. At BAREP he had created the firm's quantitative futures fund, building the system from the ground up and transitioning it over (with an average annualised performance of 9.4% since 1993).

"I'm extremely analytical – maybe too much so to be a great trader. I think I was a good trader, but recognized that I would never be one of the great ones. I naturally look at things from every possible angle – this is why I think I am a good coach. I enjoy creating products with people, then guiding them to be successful in their endeavours," says Obert.

Juchault notes, "In order to survive, individual traders can have a tendency to shy away from danger. It is my job, our job, to bring them back towards the danger – not into the danger but towards it. Towards volatility."

Articulating this intervention, Obert recalls a situation that arose with Vivendi shares about five months ago in the firm's event-driven strategy. After a firm bounce from €25 to €29 per share in March 2005, the stock began to slide back towards the €25-26 level after May. Vivendi had announced plans to sell 20 percent of its Canal + business to Lagardere and its remaining 5.3 percent stake in Veolia Environnement, among other stakes, in a broad restructuring.

But in June the company announced that it was considering bidding on the 54 percent stake France Telecom was selling of its yellow-pages PagesJaunes SA.

"When we looked at it, we decided it just would not be feasible," remembers Obert.

If the deal went through shares would plummet, claims Obert. But he sat down with Anne-Sophie d'Andlau and Sylvain Lemaire [the two co-managers of the event-driven fund] and deliberated long and hard about what to do with the position. "We risked losing 2-3 percent of the overall fund," notes Obert. "But the probability was just extremely small it could go through, so we kept the position."

To date shares linger around €26, near Systeia's basis. Obert acknowledges that d'Andlau and Lemaire trade around the position considerably, but will not give any figures on how much this has netted to the firm. "The point is that you have to be patient if you really have conviction, and we believe the shares are worth 40," says Obert. "We've had a position in Vivendi shares for about a year-and-a-half."

A balanced, if eclectic offering of funds

Systeia not only tries to offer a balance between directional and relative value, and between discretionary and systematic approaches, but also seeks to offer both classic strategies and what might be considered "frontier" or "innovative" strategies. The latter would classify the company's Alternative Risk Transfer strategy, a fund that seeks to profit from investments in insurance linked securities (ILSs) and weather derivatives.

"You have to have an element that is innovating, that is seeking something new. This helps the entire organisation," says Juchault. "It guards against stale thinking."

Fabien Dornier, another BAREP veteran, runs the fund. Juchault notes that his seven years of experience in this sector make him one of the earlier players in the space.

Insurance linked securities and related derivatives mark one of the more important elements of financial market innovation in the last ten years, even if the market for these products remains relatively small at just over US$5 billion for cat bonds and a notional amount of roughly US$45 billion for weather contracts worldwide, according to Swiss Re.

"I believe that few houses can offer such a range of products that are each so different," says Obert. "Managers should be thinking about this kind of diversification. But patience is needed in some of these products, such as insurance derivatives. You really have to spend the time to educate the investors, and it's very much a longer-term time horizon – more like 7 years than the usual 2-3-year horizon we look at in other products."

Obert explains that we could be on the cusp of another big change in thinking in world markets as the low interest rate environment across the rich world draws to a close. But overall, Juchault is quick to note that he doesn't see any lurking disastrous event on the horizon. And based on Systeia's size and limited resources, Obert explains that the firm's style is to act upon the peripheral effects in such periods of big moves.

"The addition of global macro to our offering is structurally advantageous. But we're not Bridgewater [Capital]. We don't have the resources to be in front of the big moves. We need to perceive them as soon as they begin to unfold, however, and to correctly read the domino effects," says Obert. "Has the market overreacted here? Not enough here? This is where we're focused."

In other words, if conditions are causing gold to move up, perhaps there's more impact to take a position in ZAR rather than gold directly, or in certain mining stocks.

Furthermore, not all strategies will be well-positioned in all market conditions.

"Not all strategies are going to work well in all conditions – that is precisely why we have built our range of funds in this way," says Obert.

Noting that, last year Systeia out-performed the index and most of its competitors, with its CTA program which has a performance above 11%. This year, its equity quant program is up by 12.14% (as of June 30) despite the difficult market conditions.

Systeia has the ability to blend discretionary and systematic approaches, top-down and bottom-up analyses, directional and relative value trades, all in a house that preserves its entrepreneurial spirit while benefiting from the parentage of one of the European's largest financial institutions.