This inaugural edition of the Eurekahedge Absolute Return Fund (ARF) Directory contains information and data on more than 100 long-only alternative funds managed for absolute return that represent in excess of US$13bn of assets. These funds invest in securities domiciled or having primary operations in Asia-Pacific, inclusive or exclusive of Japan, and Global Emerging Markets, or otherwise derive significant earnings from Asia-Pacific, inclusive or exclusive of Japan, and Global Emerging Markets.
Only within the last three years have long-only ARFs reached a critical mass in both size and number to gain significant popularity with institutional investors. Still, the latest entrant in the single-manager hedge fund universe has yet to reach a level of prominence on par with most longer established categories of hedge fund. This directory has been six months in the making largely owing to the limited recognition of long-only ARFs.
Like hedge funds that can take short positions, the "long-only" sub-sector of hedge funds strives to earn 'real' returns for investors, not merely to emulate or outperform an index benchmark like traditional long-only mutual funds. Long-only ARFs are increasingly seen as a practical alternative to traditional funds simply because they are profit oriented (not relative return oriented) and are actively managed by seasoned professionals. This is true for each of the four trading strategies employed by long-only ARFs.
What are long-only Absolute Return Funds?
A long-only Absolute Return Fund is an investment fund that takes only long positions, seeks undervalued securities, and typically has the ability to reduce volatility and downside risk by holding cash, fixed income or other liquid assets. This fund may buy or sell options, futures and other derivatives to reduce or hedge risk and gain exposure for underlying investments when done for non-speculative or 'classic' hedging purposes. Exposure may also be gained through investment funds that are not hedge funds.
Long-only ARFs pursue alpha strategies independent of any index benchmark that it believes will result in positive returns whether markets are rising or falling. The key differences between long-only ARFs, hedge funds and traditional mutual funds are highlighted in Table 1. Each of these three investment funds is clearly distinct from one another. However, long-only ARFs more closely resemble hedge funds than traditional mutual funds and in fact are a sub-sector of hedge fund.
|Long-only Absolute Return Funds||Hedge Funds||Traditional Mutual Funds*|
|Objective is consistent positive returns in all market conditions||Objective is consistent positive returns in all market conditions||Objective is out-performance of index benchmark, depends on rising markets for positive returns|
|Flexible investment strategies including derivatives but no 'speculation'||Flexible investment strategies including active use of derivatives||Limited flexibility, generally must be fully invested|
|Seldom invests in other long-only ARFs or traditional funds||Invests in other alternative funds when Fund of Funds||Seldom invests in other traditional funds|
|Leverage used sparingly||Leverage permitted, average 1.6:1 (assets + liabilities/NAV)||Leverage rarely used|
|Mostly open-ended, mostly available to a limited number of qualified institutional investors||Mostly open-ended, available to a limited number of qualified institutional investors||Generally open-ended, widely available to retail and institutional investors|
|Large minimum investment||Large minimum investment||Small minimum investment|
|Shares or units subject to limited liquidity, normally bought and sold any business day and are required to meet a minimum holding period for redemption but rarely a lock up period||Shares or units subject to highly restricted liquidity, can be bought and sold any business day and are required to meet a minimum holding period for redemption but rarely a lock up period||Shares or units subject to daily liquidity and can be bought and sold any business day without any notice whatsoever|
|Manager's capital often at risk||Manager's capital often at risk||Manager's capital not at risk|
|Fees derived from management fee, manager awarded a percentage of profits||Fees derived from management fee, manager awarded a percentage of profits||Fees from management fee, manager paid salary and bonus by company|
|Highly skilled, experienced and knowledgeable managers||Highly skilled, experienced and knowledgeable managers||Generally less experienced and specialized managers|
|Restricted from advertising and marketing||Restricted from advertising and marketing||Generally aggressively advertised|
|Tends to be registered investment||Private investment, loosely regulated when offshore||Registered investment (US SEC and other authorities)|
|Loosely correlated to stock markets and traditional asset classes (diversification benefit)||Loosely correlated to stock markets and traditional asset classes (diversification benefit)||Strong correlation to stock markets and traditional asset classes (no diversification benefit)|
|Private placement, usually||Private placement||Public placement|
|Long only||Long and short selling allowed||Long only|
|Actively managed||Actively managed||Actively managed|
|*Not including passively managed Index Funds (also known as Tracker Funds)|
Funds by Strategy
The most popular investment strategy for long-only ARFs is Bottom-Up with over half (58%) of all Managers executing this strategy. The dominance of Bottom-Up, as illustrated in Figure 1, reflects the fact that most managers of long-only ARFs cast themselves as 'true' stock-pickers, constructing investment portfolios that heavily favour equities over all other asset classes. Well behind Bottom-Up yet far ahead of the two least popular strategies is Dual-Approach at 26%, which typically allocates outside of equities but has an obvious equity bias.
The Diversified Debt and Top-Down strategies round out the four major strategies of long-only ARFs at just 10% and 6%, respectively. ARFs adhering to Diversified Debt are fixed income funds (although convertible bonds may also be held). Funds that choose the Top-Down strategy tend to have an overwhelming debt component within their portfolios but will hold equities too.
In order for long-only ARFs to preserve capital and achieve absolute returns, the Manager's expertise is crucial. Like hedge funds, long-only ARFs are skills-based, relying on the ingenuity of professionals to analyse securities and make winning investment choices. Often this means these fund managers will call upon advanced methods and techniques to pick securities and markets that will consistently increase a fund's asset value over time.
To encourage the highest possible positive returns, the incentive-based fee structure of hedge funds has been borrowed by long-only ARFs. In particular, the bulk of a Managers' remuneration is derived from performance fees not management fees which range from 0.5% to 2% of NAV. Before any performance-related income is forthcoming (typically 20% of NAV or less), fund returns are often required to reach a High Water Mark. About 55% of long-only ARFs in the directory have a High Water Mark. A Hurdle Rate or targeted minimum gross return is also present in about 35% of funds.
In addition, because long-only ARF Managers frequently have a personal financial stake in the funds they manage, they are less likely to take unnecessary risks. This moral-hazard-reducing practice also originates from hedge funds. It is often the case that the more of his own cash a manager places in his fund, the greater the likelihood the fund will deliver above-average returns.
Funds by Physical Location of Manager
In the age of instant telecommunications, it is no surprise that long-only ARF managers can reside practically anywhere in the world without regard to distance from markets.
Nevertheless, more than one-quarter of all managers choose to live in the United Kingdom (30%), and then mainly in London. The pronounced affinity for London in particular and the UK in general is a function of, first, that the UK has the largest concentration of hedge fund managers found anywhere, which serves as a magnet for talent, second, UK financial markets are efficient and supported by a well-designed regulatory infrastructure, third, a large majority of the world's alternative investors are located in the UK so it is easier to attract assets, and fourth, managers find the London lifestyle to their taste. The upshot is that the UK's overall environment is ideally suitable for sophisticated investors and the entire spectrum of hedge funds.
Since the beginning of the new millennium, however, both the Hong Kong (25%) and Singapore (7%) fund markets have been gaining favour with professional money managers. The financial and supervisory authorities in these Asian cities seek to encourage and promote the development of home-grown hedge funds. These markets look to the UK's lead. Recent trends suggest that the number and variety of funds and the talent pool in both Hong Kong and Singapore will deepen this decade.
The remaining long-only ARF Managers are thinly spread out in Europe, Australia and Asia, as shown in Figure 2.
Funds by Investment Geography
For this directory, the region where a fund's strategy is executed, called Investment Geography, is limited to all countries worldwide with the exception of member-states of the G7 minus Japan. This broad swath encompasses Asia-Pacific, Global Emerging Markets and Japan, but excludes most European markets and North America.
Investment Geography is one of the first important considerations for investors of mutual funds, including hedge funds. As Figure 3 illustrates, well over half of long-only ARFs in this directory invest in Asian markets. Asian securities bought and sold in Asia ex Japan capture 23% or nearly one-quarter of the Investment Geography pie, while Japan is a close second at 18%.
Other Emerging Markets and Single Country each occupy 14% of Investment Geography.
* Australia, India, Indonesia, South Africa, South Korea, Turkey, Vietnam
Overall Assets vs Manager Location
From Figure 4, it is evident that the preferred locations for managers - UK, Singapore and Hong Kong - also gobble up the lion's share of overall assets. To be precise, as at September 2003 a combined US$8.8bn or roughly 80% of total assets under management (not including US$3bn worth of 'limited information' funds) was allocated within these three money centres.
Interestingly, USA and Japan account for a relatively minor amount of capital under management. Certainly Managers in the two largest economies in the world can attract large-scale investors but as Figure 4 shows, the amount (less than US$200m) suggests that the tap has yet to be turned on. In the case of Japan, however, the unimpressive size of assets onshore is more about the stultifying regulatory environment surrounding hedge funds than domestic interest in long-only ARFs. Consequently, most Japan-only funds are managed outside Japan.
A wide range of Administrators provide back office functions such as accounting, valuations, transfer agency and custody services to funds with long-only absolute return strategies. Hiring the right Administrator - one that will work closely with clients and provide regular feedback - allows managers to concentrate on their trading activities.
The total number of different Administrators used by fund managers within this directory is quite high at around 35. The Investment Advisor can act as a fund administrator although few do. The three most popular Administrators account for about 40% of market share, based on the total number of funds. The chief player is Bank of Bermuda (which was acquired by HSBC in October 2003), and its subsidiary Bermuda Trust. Not far behind are International Fund Managers and HSBC, respectively.
Depending on the complexity of the structure of the fund, the Administrator's fees could range from just a few thousand dollars a year to as much as 0.25% of the NAV per annum. Sometimes the Administrator's fees are included within the management fee. Custodial fees are more difficult to quantify but can also be a lump sum or a percentage of NAV.
From a practical standpoint, long-only alternative funds do not require the heavyweight financial services and market-making muscle of a prime broker. Nearly all long-only ARFs implement their strategies and execute trades through several brokers, including smaller-sized intermediaries.
Long-only ARFs typically never borrow equities and other securities. They do not speculatively short and therefore do not need to leverage extensively. Their derivative use is either restrained or non-existent. What's more, average transaction size and frequency tends to be less than that of run-of-the-mill hedge funds. Brokers employed by long-only ARFs also typically do not act as custodian; the Administrator performs this task and can also settle all transactions. And of course, not having a prime broker means long-only ARFs do not pay prime brokerage fees.