AllAboutAlpha.com contributor Timothy Laing reports today from The Dolder Grand hotel, over looking Zurich on this week’s Hedge Funds World Zurich conference…

“How many of you think the Sharpe Ratio is bull****?”

With characteristic bluster, author Nassim Nicholas Taleb addressed the audience of hedge funds, investors and service providers assembled before him earlier this week in Zurich (Hedge Funds World Zurich). Overall, it’s safe to say that Taleb doesn’t like quants.  He says he prefers to keep things “as simple as possible“, to plan, and to wait patiently for an unlikely, yet inevitable turn of events (i.e. the storied “Black Swan”).  But unfortunately, this is not a typical strategy in the financial markets.  Prop desk traders do not get paid to wait; pension funds cannot go 90% cash and 10% options; and hedge funds managers do not get paid to “keep things simple”.

Taleb is an options trader - or to be more precise, an options buyer.  Since the investing public often has a tough time with the concept of short selling, Taleb’s strategy might seem complex - but it’s not.

Essentially, he buys cheap insurance on all sorts of things (many, many, things) pays monthly premiums and - like a hunter - waits for Black Swans. He firmly believes that Black Swans are more plentiful than option sellers realize. Thus, he figures that the playing field is tilted in his favor. In the meantime, he ends up providing liquidity to capital markets.

Naturally, he also had a lot to say on the subject of risk management/measurement - arguing that “stress testing is useless since it tests the past and not the possible” and that “the 1,000 year flood cannot be seen in 100 years of data”. In addition to his critique of Sharpe, he went on to fire well aimed shots at VaR, portfolio theory, and the people who use these tools. He says simply that classic statistical tools do not apply to financial markets.

Taleb is a commensurate salesman. He and his colleagues know that most people do not have the ability to execute his strategies on their own, and that Wall Street’s bonus system keeps the competition out of their trades.  His stories are full of the kinds of colourful anecdotes that experienced traders love to relate.  He likes to shock his audience and is no stranger to the colourful language synonymous with successful traders. He is clearly one of the smartest guys in the room. If only Enron or LTCM had hired Taleb, history may have unfolded differently.

But at a major hedge funds conference, especially one in Switzerland, you expect to meet smart people like Taleb.   Gerlof de Vrij, Head of Global Tactical Asset Allocation at Dutch government pension fund APG Investments, is another one these.

de Vrij told the audience that “we are experiencing a flight to simplicity“.  He doesn’t think much of structured products or hedge fund replication, and believes that while you may be able to replicate the details you cannot replicate “the intelligence”. During a panel discussion on Wednesday, he accused many hedge fund managers of being too beta-oriented (i.e. long-only “closet-indexers”), and said that investors with appropriate capacity and infrastructure could simply trade many of these strategies themselves. Taleb would probably agree.

There was considerable discussion surrounding fees, lock ups, and gates at this year’s event. The common feeling was that lock ups and gates should be strategy dependent. Lock-ups for a managed futures fund would be a tough sell, for example. But a distressed fund could more easily make an argument for such a provision.

At the same time, many felt that fees should better reflect the new manager/investor relationship.  Kerrin Rosenberg, CEO of Cardano UK, suggested that “1 & 10″ might be a fair fee for an investor who agreed to a two year lock up, but “2 & 20″ was more suitable for an investor requiring immediate liquidity (or, as Rosenberg put it, an investor “who may panic at the wrong time”). He also made the point that the management fee should only serve to cover fixed costs and is therefore too high for most large funds (who require much less to keep the lights on).

At conferences like this, it’s often difficult to maintain audience attention during sessions on hedge fund regulation. Patrice Berge-Vincent of the French regulator, Autorité des marchés financiers, gave it a good college try.  However, in this blogger’s opinion, Gerlof de Vrij’s “flight to simplicity” seems to have bypassed Paris’ Charles de Gaulle airport.   Indeed, it often seems that regulators are embracing greater complexity, just as investors are demanding more simplicity.

The recent market calamities may have placed an elephant in the room here in Zurich. Many wondered how - or even if - risk management models should hereinafter reflect what has recently occurred. Michael Brandenberger, CEO of Complementa Investment Controlling, was asked how he would adjust risk management systems in light of recent events. His answer sums it all up:

“What happened to HFs over the past few months was not statistically possible so it is going to be difficult to adjust risk management models to reflect what has happened.”

You could hear Taleb smiling.

Timothy Laing, CFA, CAIA is Head of Business Development at Plenum Investments in Zurich.  The opinions expressed in this guest contribution are those of the author and not necessarily those of AllAboutAlpha.com.