There has been a burgeoning interest from global investors over the past four years in the Asian hedge fund space. Newly launched fund managers with a good business model and compelling performance are getting above the critical mass needed to run a business much faster. Notwithstanding the much-abused catchphrase 'Asia is hot', the region is indeed still characterised by information asymmetries, and an understanding of the industry's growth and performance dynamics is not without its benefits. It is to this end that this write-up highlights some of the key trends in Asian hedge funds over the past few years.
The average fund of funds, institutional and family office investor has realised the necessity of making trips to Asia to do their due diligence. This is evident from the sharp increase over the past year of European- and North American-based investors travelling to the Asia-Pacific region. It appears that global investors have been underweight in the region for so long that there is a scramble to allocate to Asia. This scramble has been increased by the perceived1 lack of capacity (usually US$300-500 million) in the average established Asian/Japan hedge fund.
At the moment, Asia-Pacific markets make up 15% of the world's market capitalisation but Asia-strategy funds represent only 6.5% of the world's hedge funds by assets, up from 3% five years ago. The robust growth seen since 2000 (38% per annum growth in assets), is an indicator that this disconnect is continuing to close.
|Year||Size of Industry (US$m)||Increase|
The out performance of Asian hedge funds relative to their peers in Europe and North America has been another driver of increased inflows. The lacklustre performance in US- and European-oriented funds has meant that investors have had to look further afield to maintain the performance of their portfolios.
The graph below shows that Asian funds not only performed better than the key equity index (MSCI Asia) but also their global peers.
Fig 2: Index Returns Comparison
There has also been a gradual realisation that Asian-located funds running an Asian mandate produce better performance than funds trading the region from New York or London2. The recent increase in the opening of offices on the ground by large, established US and European funds shows the realisation that nothing can replace good, on-the-ground, fundamental research in the locale. This perception bodes well for locally based managers.
Understanding the critical path analysis of forming a hedge fund is vital to the process of raising money. An outline goes like this:
- Finding your partners and sorting out investment strategy, location and equity stakes - two months.
- Deciding and signing up with a prime broker, administrator, lawyer and accountant - two months.
- Creating company structure and submitting regulatory documents - one month.
- Getting regulatory approval - this depends greatly on where you decide to locate your head office. Hong Kong, for example, has received much press regarding the length of time it takes to register. Fund managers on occasion have had to sit exams and wait up to eight months for a simple advisory registration. Singapore, on the other hand, has a regime that allows almost immediate initiation of operations.
The quickest we have seen the process completed is four months, but putting a year into your timeline is more realistic.
Marketing prior to having a full set-up is difficult. Without a full set-up, not only do you jeopardise your relationship with a future potential client by turning up with nothing to sell but you can also fall foul of regulations. Always get good legal advice on pre-marketing materials and pitches to investors in various jurisdictions, especially the US.
However, once the firm and fund is legally set up, it is best to do a major marketing trip four to six weeks before the fund's launch. This allows the manager plenty of time to still deal with start-up issues before the fund's launch, as well as for the manager to meet with potential investors and collect business cards for the fund's initial monthly distribution list. Also, the manager will have little time to meet with investors in situ for 6-8 months after the fund's launch - to concentrate more on performance than marketing. It is important to be realistic about this pre-launch marketing trip; it is very unlikely that any investors you meet will give you 'seed' capital. For 90% of hedge fund launches, Day 1 money comes from the partners and family/friends. This should be thought of as an introduction of the fund to potentially interested shareholders.
On which market to target, the pie chart below shows the source of funds for Asian managers as at May 2005.
Fig 3: Source of Funds for Asian Strategy Hedge Funds
Soft marketing is making sure your contacts and potential investors are aware of your initial performance. The contact list and emails you gather lie at the core of making sure your potential buyers have you on their radar screen. It is worth doing some soft telesales to make sure your information is going to the correct person and not just being deleted as spam.
These initial months after launch should be about one thing for the manager – performance – and anything that distracts you from that is secondary. A manager's sales skills can dictate success, so if you do not think this is one of your talent, it might be well worth hiring or at least identifying a member of the firm to perform the marketing function.
Get on Your Bike
Six to nine months down the road is when the 'harvesting' begins – flying round the world convincing people of your ability to make money. Mediocre funds can garner masses of support just by getting on their bikes and working a group of core clients; you will not find out who those clients are unless you visit as many people as possible. Truly talented managers can languish with low assets under management for years simply because they did not run the gauntlet.
The funds that we see growing quickly in the first year are run by managers with a proven track record with other firms.
Though the 12- to 24-month rule has slackened for obviously talented managers, at the early stage you are most likely to have investors pledge a smaller amount with an option to invest more at a later date depending on success.
Allocators do not make decisions quickly. You should have as many meetings as possible in your initial hard marketing phase but expect investors to play the waiting game for at least six months after the initial introduction.
You must be prepared to have due diligence teams asking you a lot of hard questions. You should be prepared to visit or be visited at least three times during the process, especially from those investors who want to allocate more than US$10million. Do not underestimate the amount of time it takes filling out documents and answering questions from potential investors.
The good news is that the lack of capacity in established funds means that more attention is being given to recently launched funds with low assets under management. The 'nothing less than US$40 million rule' is becoming less prevalent in Asia. There are even 'emerging manager' funds of funds being launched in the US and Europe to take advantage of the perception that new funds perform better than their older, larger counterparts. Some of these funds demand an equity stake, but managers with a proven track record should be aware that as long as they can hold their nerves, they probably do not need to go down that route.
There are a couple of things you need to figure out before you take the seeder route.
- How much of the equity are you willing to give away.
The common rule for seeders is that the percentage of equity they request matches the initial seeding amount. They will make sure that the performance/management fees are tied into the vehicle where they have the equity stake. You as the manager must feel comfortable with this.
- How big can you get before you dilute performance.
If you have a seeder as a significant shareholder, they may seek to enforce a size limit so as not to potentially impact their returns. Their opinions may not be in line with yours.
- Know the best possible structure for potential seeders from the start.
If you do not put an appropriately regulated structure in place, you may have to scrap it at a later date and that can be not only a serious setback, but also extremely costly.
- Be aware that a single initial seeder can be dangerous since a withdrawal can spell the end of your business.
Where the Money Comes From
The portion of capital coming from the North America is growing. It should be noted that only.
Though allocations from North America are growing, Switzerland is the first major stop on any marketing tour. Investors in Geneva and Zurich have more experience allocating to Asia and an easier regime as far as structures, tax and regulations are concerned. Swiss investors also tend to get involved at an earlier stage than North American investors.
Recent moves by the SEC to increase protection for US investors and the level of transparency from hedge funds mean that it is not just a simple case of investing in a master-feeder structure.
Master-feeder structures have become cheaper to put in place as more law firms have entered the Asian market for setting these up. The real chore may be complying with SEC regulations on registration. There are further chapters in this book on the new SEC regulations, but in brief, if you have more than 14 US-based investors you will have to comply with the regulations. This may mean extra headcount in the form of compliance and risk management personnel.
Here is some brutal advice on marketing:
- Apart from being one of the top 3% in performance, money will not come to you. You have to go and get it, unless you are among the top five performers.
- At your previous asset management or investment bank firm, everything was done for you. At a start-up hedge fund, nothing is and you are on your own.
- Keep your presentation short. The 30-page and 25-minute rule (maximum) applies, ie. you should have got through your presentation, which should have around 30 pages, in 25 minutes and move on to questions and answers.
- Use the meeting for yours as well as the allocators' benefit. The questions that you should get an angle on during the course of the meeting are:
a. What is their appetite for Asian hedge funds?
b. Within their organisation, how are decisions about allocation made and what do you have to do to get a positive decision on an allocation?
c. When are they next in Asia or when the follow-up meeting is?
d. Find out what they need (due diligence questionnaires, references, detailed CVs, etc).
- If the allocator asks for further data or background, write it down and remember to send it. We continue to be amazed by how often we hear the refined 'we were quite impressed by X but they said they will send us more information and then we never heard from them again'.
- Also be sure to get the investor on your monthly performance distribution list.
- Go to as many relevant conferences as possible or have the appropriate member of the team doing so. Tell your potential target audience someone will be there and available for meetings even if you are at the office.
- Remember that even if you do raise assets quickly, money can disappear as quickly as it came in if you do not perform. An increasing number of managers have the experience of accruing assets in the first 12 months just to see that money disappear through lack of performance. Thus it is important to be constantly meeting with investors (at your office) even if they are not in the fund, because you never know when your AUM may fall.
- Don't be afraid to compare notes with other managers; experience is valuable when marketing.
Though you will find allocators more favourably predisposed to your Asian or emerging markets fund, if you are going it alone, you will still find the classic evolution pertinent:
- Start with US$5 million of partners and friends' money.
- Struggle to get to the sweet spot of US$75-100 million in 6-18 months.
- If performance is good, then a stampede occurs.
- Within nine months, fund closes at US$300+ million or whatever the appointed size and the manager will now be turning away money.
The main thing is not to become despondent in the first year even if your performance is fine but you are not raising big money. Time, effort and performance will make it through.
This article first appeared in a hedge fund and investor guide Eurekahedge produces on a yearly basis called The Asset Growth Guide. This book is a free text for hedge funds, investors and interested parties in the global hedge fund universe. If you would like to receive your free copy of this book, please contact firstname.lastname@example.org. (Please be aware that since this is a free text we need you to pay a nominal amount for postage and packaging dependent on your location.)
1 Perceived insofar as well-known start-ups close very quickly and this could imply a drying up of avenues for investors. But the markets still has a number of long-standing (but not as well-known) funds, which investors might not be aware of.