: John Berthelsen
Date : 25-09-04
Source : The Standard - internal
With Hong Kong's smog-saturated summer drawing
to a close, the financial world's migratory birds
are starting to fly in for their annual visits.
For glitz, it will probably be hard to beat CLSA's
11th annual Investors' Forum two weeks ago, which
featured a concert by Elton John, or this week's
Forbes CEO forum, which featured Stephen Roach,
Morgan Stanley's notoriously pessimistic chief
But, sandwiched among them was the 7th annual
Hedge Funds World Asia Conference, whose delegate
count zoomed to 535 this year compared with 400
That is emblematic of the sudden steep rise in
activity in Asia-based hedge funds, which at the
start of the year covered US$34.5 billion (HK$269.1
billion) in assets. That figure is expected to
jump 59 per cent to US$55 billion by the end of
Market capitalisation of the funds, which use
a variety of strategies in an attempt to offset
market risk, has risen 40 per cent to US$49 billion
in the year to date, both through asset flows
That is about 7 per cent of hedge fund assets
across the globe, with around US$800 billion now
Some 97 new Asian funds were launched in 2003
and another 21 so far in 2004, according to Eurekahedge,
the Singapore-based hedge fund consulting group,
bringing the total number of Asian funds to 415.
That US$55 billion in market cap is admittedly
tiny when compared with the total market cap for
equities in Asia, which is about US$1 trillion.
But ever since the market crash of 2000, the conventional
mutual fund industry has been under attack for
its minuscule yields.
Where in the past US stocks, for instance, had
an average real return of 7 per cent annually,
today that has fallen to 4.3 per cent by income,
or just 1.1 per cent real growth after inflation,
according to Research Affiliates.
In addition, given the cumulative loss to the
mutual fund industry's reputation prior to the
crash, many analysts are concerned that the industry's
business model is under threat. Certainly, these
flat returns have driven investors to new places
to put their money _ of which there are few. Bank
saving rates are so low that fees eat up whatever
is earned. Bonds are not priced to offer real
returns above about 3 per cent.
Money market funds are equally flat. Currency
trading is hazardous _ ask the hedge fund managers
who bet against the US dollar versus the euro
earlier this year.
Thus, after relatively lacklustre growth from
their inception in Asia in 1989, the Asian Financial
Crisis of 1997-1998 caused growing increases in
the number of funds coming to the market _ from
fewer than 10 a year in 1996 to nearly 100 last
They have have been increasingly attractive to
investors, and they are finding new ways to lure
the retail investor. These funds until very recently
have been the investment vehicles of the very
rich. Typical is the FTSEhx PC fund, a Cayman
Islands fund launched on May 31, which requires
a US$500,000 initial investment with a minimum
of US$100,000 in any class. It requires another
US$100,000 for any additional investment. But
as hedge funds have started to go after retail
investors, instruments like the London-based Man
Hedge Diversified Ltd ``fund of funds'' have come
Funds of funds are an increasingly popular investment
vehicle that invest only in other open-end funds
and are aimed at investors who have a relatively
paltry US$20,000 to spend and are willing to lock
it up for five years.
The fund is targeting growth of 15 to 17 per
cent a year. This new access to hedge fund vehicles
is fuelling an increasing rush by small investors.
But beware. That 15 to 17 per cent performancethat
Man Diversified is targeting is actually fairly
far from actual performance by hedge funds across
the board, which is probably closer to 3 to 5
Many of the funds are under water. According
to Eurekahedge, ``50 per cent of hedge funds are
currently non-economically viable business entities''.
Five per cent of funds were at least 20 per cent
below their high water mark at the end of 2003.
Of Asia's 415-odd funds, fully 40 per cent are
estimated to have assets less than US$25 million.
As Eurekahedge pointed out in its latest study
of the Asian hedge fund industry, ``those that
are based in Asia outside Japan will have a low
cost base, but usually they cannot survive for
more than two years with less than US$25 million
in total assets''.
Some 85 per cent of the money going into Asia
hedge funds goes to fewer than 40 funds, the most
successful of which are Lloyd George, Boyer Allen
and Sloan Robinson, large institutions like JF
Funds, Gartmore, GAM, Man or Henderson, or hedge
funds where the lead manager came from such funds
as Soros or Tiger.
More typically, the hedge fund operator is likely
to be a former investment banking analyst or salesman
who racked up hefty bonusesthrough the unspeakably
rich _ and aberrational _ 1990s for investment
banks and found himself either unemployed or downsized
into a less-rewarding job after the 2000-2001
market collapse. He or she took the hefty cash
reserve built up during the fat years.
Armed with intimate knowledge of a particular
sector and a particular geographical area, the
new hedge fund operator set up the Joe Plotz Long/Short
Equity Hedge Fund and started looking for 25 investors
with US$1 million each to invest.
Long/short funds are probably the least complicated
of hedge strategies. They are the most ubiquitous,
comprising 64 per cent of Asian hedge funds by
assets, according to Eurekahedge. They take their
name from the way managers make investments, seeking
to keep their portfolios buffered against market
volatility. Against their typical ``long'' positions
_ buying some equities in conventional trades
_ they take short positions as well, selling securities
they do not own yet, gambling that they will be
able to buy the stock at a lower price than the
one at which they sold short.
The trouble, according to Man Investments regional
manager Matthew Dillon, is that "just because
someone is good at being long, it doesn't mean
they have the skillset to go short''.
Going long has limited downside because a share
price cannot go below zero. But if the shorted
share's price skyrockets before the day the buyer
has to clear his position, the capacity for disaster
is virtually unlimited.
The hedge fund manager with limited resources
who starts to go into the hole will begin to discover
it takes a lot longer to get out than to get in.
"They might know that's not going to happen
for two years,'' Dillon says. "Is it economically
viable to stay in business? It might be wiser
to close down and start up again. For these small
players, you really have to view them as a business
It pays to remember that that hedge fund manager
is the same guy who persistently got it wrong
as an equities research analyst or salesman. "You
might make 40 per cent in one year, but if you
can't survive in a drawdown, you're out of business,''
"To effectively raise money, the management
team needs to be travelling constantly to see
prospective investors,'' according to Eurekahedge's
analysis of the industry. "If there is only
one manager, time away from trading is severely
detrimental to the fund's performance.'' Accordingly,
a boutique fund needs at least one secondary manager
to double as a marketer or someone who understands
the fund's investment philosophy. Another well-publicised
problem for Hong Kong is that of Asia's 415 hedge
funds, only 13 are registered with the Securities
and Futures Commission.
"It is an industry that is less well-regulated
because it is targeted at those deemed able to
look out for themselves,'' one private investor
said. "But it is increasingly being entered
by retail investors who are used to being able
to place much more reliance on the regulators.''
In addition, he and other investors say, is that
some hedge funds have very wide briefs and can
do anything they want as to asset classes.
Thus a bewildering stew of funds is coming to
the market. These other funds are into such esoteric
fields as convertible arbitrage, which involves
buying convertible securities and shorting the
corresponding stock. The conversion is intended
to offset the short position, and reaping profit
if the convertible is priced incorrectly relative
to the stock itself.
Buying distressed debt, using multiple strategies,
going for "event-driven'' strategies, commodity
futures, options and foreign exchange are other
strategies. As the funds grow more esoteric, they
can involve increasingly high degrees of leverage
that can either result in substantial gains or
even more spectacular losses.
You have the possibility for a spectacular collapse
if something goes wrong,'' says another private
investor. Nor, against all odds, are small operators
alone. The investing world seems to have learned
few lessons from the near collapse in the late
1990s of Long Term Credit Management, at the time
the world's biggest hedge fund, which lost massively
by leveraging bets on exotic derivatives trades.
Federal Reserve Chairman Alan Greenspan and then-Secretary
of the Treasury Robert Rubin were forced to organise
an unprecedented bail-out by 16 banks to the tune
of US$3.2 billion against the threat of the destruction
of the world's entire financial system.
Likewise, Tiger Management, one of the world's
largest funds, with more than US$20 billion in
management, lost as much as US$2 billion in a
single day in the late 1990s by borrowing yen
and investing proceeds in dollars. When the yen
strengthened against all predictions, Tigerlost
heavily and investors began pulling out. In nine
months in 1999, Tiger lost 23 per cent of its
Retail investors are also at risk _ or possibly
in for bigger returns in the form of institutional
investors such as pension funds, universities,
banks and others. They have been increasingly
returning to the hedge fund market.
A study by Greenwich Associates, a US consulting
firm, found that 23 per cent of US pension funds
are now investing in hedge funds, compared with
just 12 per cent in 2000. The proportion of Japanese
institutions investing in hedge funds is even
higher, doubling to 39 per cent in just the last
So is there a bubble coming?
Eurekahedge calls the suggestion ``premature'',
saying that the industry in Asia is catching up
with the rest of the world. Institutional firms
such as JF Funds are now beginning to launch their
third- and fourth-generation funds.
Man's Dillon says his fund of funds, due to close
in October, is raising US$1 million a day. He
fully expects to meet his US$20 million target
well in advance of the closing date.
But it pays to read the fine print. For instance,
one commodity, futures, options and forex fund
contains this chilling language:
"The risk of trading is substantial. The
high degree of leverage associated with commodity
futures, options and forex can work against you.
This high degree of leverage can result in substantial
losses as well as gains. You should carefully
consider whether commodity futures, options and
forex is suitable for you in light of your financial
condition. If you are unsure, you should seek
professional advice. Past performance does not
guarantee future success.'' Indeed.