Research

Kenneth Hung is the fund manager for the Trophy Fund, a long/short equities pan-Asian hedge fund. The fund returned almost 300% in 2003 and has posted an annualised return of 57% since inception in September 2001. They currently have US$8 million in the Trophy Fund and US$10 million in a separate managed account.

Interview with Kenneth Hung

1. Can you first give us a brief outline on the key individuals at Winnington Capital?

   We have five people. I make most of the decisions. I have two assistants, one with an accounting background who does research and analysis of companies; the other is a computer programmer who filters and screens companies and markets.

2. So, need I ask how 2003 was for you? What do you attribute the success to?

   2003 was a good year for us; our investment formula was proven right. I think we can categorise the profits we made in largely four areas. The first was in a position of a small company we bought in mid-2002. It initially went down but we were very confident of its prospects that when it started to go up again, we increased our exposure. Eventually we made 10x our money over 18 months. The second trade was Petrochina, a stock that we knew well and traded previously. When Warren Buffet took a stake in it, we took a large exposure and made decent money in the following four months. The third area was when we cashed out of most of our exposure in the Chinese market during the mini-euphoria in that market in late November and December and as a result the fund was up 40% in December. We also made money trading the precious metals during the year.

   Our success is due to our ability to identify undervalued companies for the long term; and our "feel" for the markets that provide us with short/medium-term opportunities. With long-term investments, we follow them closely and determine the optimal timing for exits without becoming sentimental. Short/medium-term trades require different techniques, which are a combination of screening, market instincts, timing and stop-loss controls.

3. Which markets did you find the best returns in 2003?

   The best returns usually happened in areas where one is most comfortable in at that moment in time. In 2003 it happened to be in Hong Kong.

4. Due to the strong Asian markets in 2003 most long/short funds had a high beta correlation to the markets. Did this apply in the case of the Trophy Fund and what was your average net and gross exposure for the year?

   I don't think we had a particularly high beta correlation, because some of our trades did not correlate to the markets. We do not like high borrowings. In 2003, our average gross exposure was 97% of NAV and net was around 80%.

5. Despite the excellent returns over the past year do you find investors put off by an annualised volatility greater than 50%?

   Perhaps they would have less of a concern if they understood how that volatility came about. A lot of the volatility was due to drawdowns on the profits we made. For instance, on the small company I mentioned earlier, we bought the stock at $0.26. When it first went up to $0.80, we did not sell any shares (because the best news was yet to come). It then corrected to $0.50, which was a sizeable drawdown and volatility. We eventually sold most stocks six months later between $1.30 - $1.50.

6. You claim that your research is mainly proprietary internal filters and models, company visits, as well as external. Can you explain in more detail and how many company site visits do you perform annually?

   We do about 30-40 company visits and presentations each year. The companies we are keen on, we usually get to a level where we have direct contact with the management. In some cases, we would try to help them with M&A, strategies, directions and PR; so they like us as well.

7. Do you employ automatic stop-losses and if so what are they? What other risk management measures do you implement to avoid large drawdowns?

   We are more disciplined with stop-losses on our short-term trades. On the longer-term trades, we would evaluate the situation, and if the fundamentals are still intact then it could be a good opportunity to increase the exposure, but I do not have the ego to double up for the sake of it. When we are unsure of something, we usually get out or halve our position(s); so when we trade well, we increase our exposure, and when we trade badly, we decrease.

8. What are the main pitfalls in trading Asian markets? Any short selling frustrations and obstacles?

   There are certain pitfalls like the inability to short in certain markets or stocks, but they do not bother me too much. The markets provide me with enough volatility, and I like volatilities. Even though I have a derivative background I do not sell volatility.

9. Can you give a brief background of yourself and your past achievements? I started my career in London with the stockbroker, Sheppard & Chase, in 1983. I was fortunate enough to have started out in research under the late Piers Hughes, who I consider to have one of the best brains in the City at the time. Then I moved into fund management. I won the annual staff stock tip competition two years in running (out of some 80 analysts, salesmen, and fund managers) in 1984 and 1985; I decided it would be unwise to participate in 1986!

   I was then promoted to the parent bank, BAII, to set up the capital markets operation in Hong Kong, trading Japanese warrants and convertibles. After two years, I went to work for a prominent family on direct investments in China. At the time, direct investments were very good experience, but it was 10x the effort and 1/10 the returns. So I joined Peregrine Equity Derivatives in 1996, and was responsible for marketing derivatives, including the best performing covered warrant in Hong Kong in 1996 (out of some 500 warrants issued in the market), which went up more than 5x.

   When Peregrine went under (due to the bond department), our team was headhunted to join Commerzbank. After a year they wanted to transfer us to London or Tokyo. That's when I decided to go on my own, and started to trade under Winnington Capital. Between 6/1999 and 3/2001, we made audited annualised returns of 290% for clients. In 9/2001 we set up The Trophy Fund.

10. Trophy Fund was initially underwater?

    Trading on my own under Winnington Capital was very straightforward. Setting up a hedge fund initially was quite different. It required multi-faceted skills; one has to deal with regulatory and legal issues, recruitment, systems, managing a business; and then finding time to trade.

    With Trophy Fund, because I wanted to set it up properly, I started with nine people. We did have more than our fair share of the start-up teething problems. Our launch coincided with 9/11, the money that was promised did not come in and there were a few staff that had big egos, so I had to downsize the whole thing after 12 months and focus on core competence. I would strongly recommend anyone thinking of setting up a hedge fund to have enough funds in the bag, so as not to worry about fund raising. They should prioritise on building a good track record.

11. How do you consider yourself different from others?

    Because of my varied background in trading (where I used to write 15-20 tickets in a day) and direct investments (profitability could take up to 3-4 years), I am comfortable to trade short term or take long-term view. I have developed a discipline to run winners. My training has always been on stock picking and finding profitable investments for clients, "if the clients make money, we'll make money", hence it became relatively easy for me to trade for a living.

12. And lastly what is your capacity and how are you intending to attract investors in 2004?

    Trophy Fund is an Asian-biased global fund, so we probably would not need to review our capacity until, say US$1 billion. We had not done any marketing for 2.5 years until this month when an investor invited us to participate in conferences in Geneva and Zurich. Attracting investors is important, but it's equally important to have long-term investors. I think it's vital for potential clients to get to know us; how we make money and how we lose money.

    Most funds aim to have low volatility; their returns should be between the range of 10% and 12% per annum. We target between 50% and 60%, for some months we could have 10% drawdowns. It's very easy for someone to say we are too volatile, but volatility can also be good. Anyone who had 5% of their assets in Trophy Fund in 2003 would have lifted their overall performance by 15%.

Contact Details
Kenneth Hung
+852 2913 7000
kh@winnington.net