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Risk Warrior

Published in Automated Trader Magazine Issue 37 Summer 2015

Miranda Ademaj was born in Kosovo at a time when an undeclared war was ravaging the area. Her parents fled with three children in tow to Germany, leaving everything behind and only uncertainty ahead. She has since worked as a fashion model and in investment banking while finishing an economics degree; took time off to travel the world; and co-founded fund of hedge funds, Skenderbeg Alternative Investments. We ask her about risk and return, and the very different kind of modelling she does today.

Miranda Ademaj, co-founder, Skënderbeg Alternative Investments

Miranda Ademaj, co-founder,

Skënderbeg Alternative Investments

Automated Trader: Few people have such a challenging background, what has led you to where you've ended up?

Miranda Ademaj: From a social and cultural point of view, Germany was very different from what I used to grow up with in Kosovo. As an adolescent woman I recognised particularly that women in Germany had more options and a higher social status than in Kosovo, but to assert similar rights for myself in my own social environment was a year-long up-hill struggle because, as an Albanian woman, you are expected to behave according to the norms of your own culture.

I think that for my parents I was sort of a difficult kid, because I was a person that enjoyed pushing the limits and transgress boundaries. My mom asked me again and again why I couldn't be a normal girl like other Kosovar girls.

Despite being left to my own devices in a way, I managed to graduate from Economics College (Höhere Handelsschule für Wirtschaft und Verwaltung). While studying, I also had to work part-time to support myself financially. So, I went through some hardship, but that turned me into a fighter.

Since German economy was showing signs of decline at that time, I saw better opportunities in Switzerland and so I decided to move to Zurich.

In Switzerland, I was confronted with, and had to learn to adapt to, yet another culture, albeit a culture not so much different from Germany's. But, ultimately, this country turned out to have a significant influence on my life.

Life has never been easy for young people uprooted from their homes by war, making their way into a new country, which, at times, is unwelcoming. For instance, when I arrived in Switzerland, a poster of a right-wing party against public funding of integration centers for immigrants from Kosovo could be seen everywhere. This was certainly not a comfortable sight for me.

The omens seemed to be not favourable. But, the vast majority of the Swiss population is very welcoming and, "Where there is a will, there is a way". I continued my studies in economics, worked for one of the biggest Swiss banks, Credit Suisse, and, as a hobby, I did some modelling. I even had the opportunity to appear on television. I had achieved all my goals. Except one: the dream to become someday CEO of my own company.

AT: Why finance?

MA: Since a very early stage, I have been fascinated by the intricacies of the financial markets. Hedge funds, in particular, attracted me due to their secrecy, their mysterious aura. Later on, probably partly due to my traditional upbringing, I wanted to see whether I could make a difference in this male-dominated world. But perhaps I expected too much from my life and my role as a woman in the financial industry?

I needed some time off, time to come to terms with what I wanted in life. So I went on a one-year trip round Australia and South East Asia. But my predilections hadn't changed. As a consequence, I started to work for a fund of hedge funds pioneer in Zurich. There I met some great people. People who understood my perspective in life, who were enthusiastic, intelligent and highly educated.

One day, after having gained a lot more of experience, my last unfulfilled dream resurrected and I decided to create my own company, a spinoff of our employer, Brunner Invest AG. I partnered with two colleagues and we created a company, called Skënderbeg Alternative Investments named after the medieval Albanian freedom fighter Gjergj Kastrioti Skënderbeg.

Skënderbeg Alternative Investments is named after a national Albanian hero, Gjergj Kastrioti (1405 - 1468), who led a rebellion against Ottoman rule in his homeland. The red standard with a black double-headed eagle from that time remains part of the country's flag.

Everyone thought we were insane to launch a fund of funds in a time when the reputation of hedge funds was at rock bottom. There were even some bets against us. But we believed in our conviction and set up clear goals. We founded our company, against the odds, at first without clients, but with a clear idea, drive, motivation and a good feeling, and, luckily, with some high-profile investors in the pipe-line. And our dream to launch our own fund of funds, which we initially thought virtually impossible, did come true! After only three months, we received a multi-million commitment from a seed investor that enabled the launch of our fund.

All countries that are dear to me are represented in our company. The chief investment officer is Swiss (Bruno Schneller), the chief risk officer (Thomas Fliegner) is German and I, as the CEO, come from Kosovo. Each nationality has its strengths and by combining those strengths, we have built a strong team.

MA: I think the biggest one is to change the perspective that, in the male-dominated hedge fund industry, women only have assisting roles, in particular if they are good-looking. Thus, it's not surprising for me to hear the question: "What's your role in the company, Miranda?" In meetings, I'm most often the only woman. That's kind of a weird feeling, being the only woman in this environment, but actually, I don't care, because I know my skills.

AT: What is the biggest challenge you face in the financial industry?

At the end of the day, the fact that I'm a woman in the industry is in our favour and gives us a competitive advantage, because the way women approach investing works in their favour.

Men tend to take decision-making into their own hands. They are also more likely to make impulsive decisions in response to the markets. For example, a study in support of this assertion proved that women were less likely than men to sell equities during the 2008 financial crisis. It turns out that being a thoughtful, patient investor pays off. Women simply perceive risk differently from men and tend to manage their portfolios accordingly.

AT: Dealing with uncertainty seems to have been a part of your background, how has that informed the kind of investor you've become?

MA: People who experienced uncertainty - and certainly war - have a very different understanding of and relationship with risk than people who come from a quiet academic background, free of fear and uncertainty. My dark years offer many relevant lessons - about life, politics, financial markets, wealth, and survival - that can help investors like us to deal with adversity and difficult times. For example: In war, there is often no second chance. This can be transferred to the investment strategy.

I think that risk measurement and quantitative tools are critical aids for supporting risk management, but quantitative tools alone are no substitute for judgment, wisdom, and knowledge. Fund managers must be, before anything else, risk managers in the true sense of managing the risks. As Peter Lynch, the famous US fund manager said: "Investing is an art, not a science, and people who quantify everything have a big disadvantage." When situations of uncertainty arise - like we have today - the best defense is to be as well informed as possible. We have a concentrated portfolio, because it's better to really know your underlyings than to be overdiversified with things you don't understand.

Many recent studies have shown that a fund of hedge funds can obtain all the diversification required by simply investing in only 10 to 20 hedge funds. This number is even lower for specialised fund of hedge funds. Excess diversification increases left-tail risk and lowers returns. The last fact is usually attributed to the cost of due diligence that increases with the number of hedge funds. Moreover, it has been demonstrated that the variance-reducing effects of diversification diminish once fund of hedge funds hold more than 20 underlying hedge funds.

Therefore, Skënderbeg seeks to maximise diversification while minimising the number of manager allocations. In our opinion, concentration is critical to superior long-term performance and survival. The Skënderbeg Fund invests in 10-15 "high conviction" funds.

AT: Can you give me a breakdown of the kinds of funds you invest in?

MA: Our investment universe consists of global long/short equity funds with low net exposures. Thus, we are a single strategy, specialised fund of hedge funds that is far less likely to experience difficulties during market turmoil. The investment philosophy of our fund is based on the motto "boring is good".

There is a very good quote from Paul Samuelson, the American economist, who points this out: "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas".

We need some risk to make returns, but we don't want drawdown risks.

The Skënderbeg Fund has a very low live beta and a slightly negative correlation to the markets. We invest in smaller but established high quality hedge funds that are "below the radar".

We construct our portfolio from these funds aiming at a maximum degree of diversification within our chosen strategy. To achieve this goal, we consider aspects like correlation, performance drivers, past behavior during market downturns etc. In short, we are considering both quantitative and qualitative aspects in the portfolio construction process.

Miranda Ademaj and Bruno Schneller (right) receiving Hedgeweek Global Awards 2015 for "Best Specialist Fund of Hedge Funds."

AT: What kind of funds do you find most interesting and why?

MA: Skënderbeg utilises a global and generalist approach, which provides us with maximum flexibility to consider opportunities regardless of region or sector. As generalists, we avoid getting bogged down in the weeds of any one country or industry. Rather than trying to pick the "prettiest pony in the glue factory", we are able to sit back, connect the dots and locate funds with attractive risk/reward characteristics.

As a result, the Skënderbeg Fund invests globally. The fund, however, does have a bias towards Europe-based managers. This fact does not mean we intend to make a portfolio call based on some top-down view of Europe. The bias is not pre-ordained, but rather the result of bottom-up work and the better liquidity of European funds.

The multiple faces of uncertainty: Miranda Ademaj at TEDxTirana

We avoid long-biased and traditional long-only equity strategies. The key risks of these investments are that they are highly volatile and, in certain market environments (such as bear markets and crisis situations), they have the potential for large drawdowns and low or negative returns for prolonged periods of time. Most long-biased or long-only funds invest along similar generic, conventional lines, proving John Maynard Keynes's dictum: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."

This is not only true for long biased and long-only strategies but also for funds (including hedge funds) of large houses and large funds in general. For reasons of reputation they cannot afford to be "innovative" out of fear that something could go wrong.

The current market environment provides an excellent case in point for the disadvantages of long-only respectively long-biased investments. While they have performed well historically, going forward there are many who believe that these investments will underperform. Investors limited to such investments are hand-cuffed into profiles that only perform in one of three possible market scenarios (that is they only perform if markets rise, but not in flat-market and declining-market scenarios). We are paid to find innovative funds that have the potential to make money regardless of market direction. Having gained significant experiences at a fund of hedge funds during the financial crisis, we view the lessons learned from 2008 as a critical component of our investment philosophy and a long-term edge over our competitors.

AT: The future is expected to have increased divergence in markets, monetary policy for example. How does this affect your decision-making?

MA: Basically the entire rally in stocks post-2009 has been due to central bank intervention of one kind or another. Whether it be by cutting interest rates, printing money, buying bonds, or verbal promises to do more, the Fed and others have done everything they can to push stocks higher. As a result, today, more than 90% of market price action is based on investors' perceptions of what the central banks will do, not fundamentals. For instance, if bad economic data hits the tape, the markets tend to rally because investors believe this will result in central banks having to print more money. All in all, this has created a difficult environment for fundamental investors.

2014 for example was a challenging year for most active managers, regardless of their strategy or style bias. According to Morningstar, 80% of US equity fund managers underperformed their respective benchmarks, publicly reported to be their worst relative performance in 30 years. Hedge funds, especially those managing long/short equity strategies, also had a challenging year.

While there are a multitude of reasons for this broad-based underperformance, low relative volatility, low dispersion, and higher relative correlations among individual stocks were major contributing factors for many managers. Historically, low volatility and return dispersion have coincided with poor relative returns of hedge funds.

Like an expert fisherman facing an empty lake, hedge fund managers found historically low rewards for their abilities to outperform indices. Tactically shifting net exposure to a stock proved ineffective due to low volatility. Daily average realised volatility for the S&P 500 declined for three consecutive years by around 50%, to a level well below the 10-year average. A hedge fund manager's ability to pick stocks also added little value in 2014, as securities hugged the benchmark, resulting in a tight spread in performance. Like volatility, the spread between the average outperformer and underperformer in the S&P 500 hit a multi-year low at just 32%. The 10-year average, in comparison, was 43%.

The ability to pick winners and losers beforehand, the skill of relative-value pairing, which is the very basis for the theoretical value of superior risk-adjusted returns in a long/short hedge fund, has almost certainly never been worth less during the existence of virtually every hedge fund. Furthermore, the ability to size positions efficiently failed to add much value in 2014. The spread between the top and bottom half of S&P 500 outperformers were just 30%, while the difference for underperformers was even lower at 22%. The good news for many active managers is that higher levels of volatility appear to have returned to the equity market. We believe, volatility will be considerably higher in 2015 relative to 2014, which should be beneficial for the Skënderbeg Fund.

We believe our fund continues to be well-positioned. We feel that our uncorrelated low beta portfolio with a low net exposure provides effective upside appreciation, low managed volatility of returns, protection in down markets, and superior risk-adjusted returns through a market cycle.

2015 promises to be a year with opportunities and it will be our job to seize those that work in the context of our strategy.

Ultimately, we think that quantitative easing will fail. With QE, central banks manufacture what they are trying to defeat. By lowering the cost of borrowing, QE has lowered the risk of default, which has led to overcapacity. Overcapacity leads to deflation. As a result, both equity and bond investments are overvalued and unattractive at the moment.

That's why we continue to favour absolute return strategies. We think there is no alternative to hedge funds right now to generate returns going forward respectively to sleep well at nights. However, it's highly plausible that the ample liquidity being provided by central banks has the capacity to continue to push asset prices higher. However, there will always be periods of relative reflection between these spasmodic paper chasing episodes; our goal is to protect capital during periods when valuation does not matter, and generate returns when the allocation of capital enters a slightly more thoughtful phase.

Experience has shown us that performance is often elusive in sharply directional markets due to the influence of heavy beta market inflows relative to other idiosyncratic factors. What we have also learnt is that once the dust settles, strong up or down moves with rising correlations can give way to adjustment periods of widening dispersion based on mean reversion trends and bottom up factors, which should again be beneficial for the Skënderbeg Fund.

AT: In terms of automated trading or systematic trading, CTAs, etc, how do you view their role as a kind of alternative asset class?

MA: From a philosophical standpoint, we don't believe in systems and we don't like to invest in black boxes. That's why we have some scepticism when it comes to CTAs. However, the human mind is one of the most significant factors in the investment industry and this potential risk factor is largely eliminated by "systems".

What we like with managed futures strategies is that in general they have historically had low correlation to stocks, bonds, and other investment strategies, moderate volatility, lower drawdowns than equities and positive returns in a variety of economic environments, for instance trending markets.

CTA strategies can be very dangerous in our opinion in the current market environment, which is dominated by arbitrary central bank interventions. One only need to think of the Swiss National Bank decision this January.

With positions in futures, the subsequent market moves in the underlying can wipe you out financially. Most CTA models were built before the financial crisis for normally functioning markets. What we think is that these models don't seem to work anymore in these liquidity driven markets. One would rather have to create a model which figures out on which side of the bed Janet Yellen or Mario Draghi wake up in the morning.

You also need to realise that "managed futures" is just an investment in future contracts. It could be a strategy focused solely on precious metals or it might include every commodity, all the currencies, and all the capital markets. Additionally, a strategy can be long, short or long & short. A strategy could be based on an automated, rules-tracking process to "trend" to a specific benchmark or open to wherever the CTA's "gut intuition" wants to go.

The number of iterations is endless. The core issue with this is that managed futures is actually a wide variety of investment strategies, not an asset class and that is a very important distinction. Past performance data on asset classes can be analysed to create some basis for future expectations. Unrestrained, eclectic investment strategies can't.