Doug Barnett, President, has 14 years' of experience in the
investment banking and fund management business, specialising
in the Thai stock market. The Thai Focused Equity Fund is
a long/short Asian equities fund, with a strong long bias
and a bottom-up value approach.
Interview with Doug Barnett
- What are your risk management measures?
The biggest risk for us is illiquidity in the market.
To control this risk, we look at the lowest liquidity
month in the last 12 months for each investment. We then
take one third of that volume as the maximum amount of
liquidity that we can count on. Anything that we own above
that liquidity limit, we put into our illiquid bucket
and make sure that the illiquid bucket is no more than
40% to 50% of our portfolio so that we can always meet
our promised one-month liquidity; we assume that no more
than 50% of our investors will redeem at the same time.
We also control drawdown risk on 2 different levels.
First, if an individual stock in our portfolio drops 20%
below its high water mark (the highest price since we
bought the stock), we would examine the situation (buy
more or cut our losses). Second, we control drawdowns
on the portfolio level by looking at the current gross
NAV compared with the high water mark on gross NAV. For
instance, if the current NAV drops 10% below its high
water mark, we would raise cash in our portfolio to 15%;
if it drops 15% below its high water mark, we would raise
30% cash and short our available short stocks. If gross
NAV dropped 20% below its high water mark, we would raise
40% to 60% cash. We would then be quite defensive and
would wait for another good entry price.
We also hedge currency to counter currency risk.
As a result of these measures, we have downside risk
of only 16.7% versus SET index downside risk of 27.2%.
To put this in perspective, the S&P downside risk
is 12.5% and the NASDAQ is 23.2%.
While we have risk similar to developed markets, our
return has been much higher. Since April 1990, we are
up 1499% vs 359% for the Nasdaq, 216% for the S&P500,
and -51% for the SET Index.
- Where do you see the greatest risk to your performance?
Having a concentrated portfolio. If we chose our stocks
poorly, that would have a big impact on our portfolio.
However, we minimise this risk of taking concentrated
positions by doing in-depth research on the few stocks
that we have, and developing very close working relationships
with those company's management teams. We are also on
the Board of Directors for a couple of our large positions,
so we generally have better information on those companies
than the rest of the market.
- What themes for both the long and short books do you
find interesting right now?
First, the short book is only about 2% of the portfolio
and right now we do not have any shorts on because we
think the market is going up.
We have not had large short positions because previously,
it was illegal to short in Thailand. Now it can be done,
but the terms on which you can borrow are 1-day call.
Lenders do not offer term borrowing in Thailand. Even
international brokers lending Thai stocks want 1-day call
on the short stocks. This is a problem because the size
that you can reasonably short is based on volume traded
on the most illiquid day in that stock over the previous
year. If you short more than that, you are taking the
risk of not be able to cover your short positions in time
to meet your call. There are 30 Thai stocks that are shortable
and the liquidity in those 30 names is not that great.
Therefore, shorting has never been a major part of our
activity in Thailand. When we short, we do it as a directional
short; when we think that the market is overbought, sentiment
is deteriorating or volume is going down. We are never
market neutral, and we seldom run hedged positions.
On the long side, the biggest theme over the last couple
of years has been the emergent domestic consumer economy.
This began in late 2000 when the world economy was slowing
down and rolling over. Thailand is an export-driven country
and at that time, the Prime Minister's idea was to stimulate
the economy and to pick up the slack where the exports
had been driving in the past.
There was plenty of idle liquidity available because
for the last 40 years, Thais have been over-saving. The
economy was also stimulated by cutting interest rates
from 10% to 1% and by the removal of taxes for buying
real estate. The reason that the government decided to
stimulate the real estate sector was that there is a big
multiplier effect in the economy as people spend more
money to decorate, furnish and maintain their new houses.
The real estate sector was the first sector to recover,
and property stocks initially led the market higher. Not
only could investors benefit from high earnings growth,
but p/e multiples also expanded as interest rates dropped.
The initial surge in real estate was followed by improved
earnings for the mass market retailers, steady increases
in the purchasing of cars and motorcycles and a big surge
in personal finance, including mortgages, credit cards
and personal loans. We initially invested in the property
developers, but the big gains in this sector have made
it more speculative. Now the only way to make big gains
is to invest in the marginal, recently restructured players
where the quality of the companies is very substandard.
However, we see good opportunities in consumer finance,
shipping, telecommunications, and a number of cyclical
companies in the chemicals, cement, steel, paper and brokerage
businesses. And we get that free embedded option of the
export sector as the rest of the world comes back online.
Even with our portfolio up 115.8% and the SET Index up
94.1% for the year, we are not worried. The SET Index
is currently valued at a PER of only 10x forward earnings,
with projected earnings growth of nearly 20%. Meanwhile,
our core portfolio is currently valued at a PER of 9.8x
forward earnings, but with expected 2004 earnings growth
of over 88%. The SET Index has historically traded between
12 and 20x PER, and speculative markets have driven it
as high as 35x, so we still see significant upside.
- We note from your template that you are not averse
to the use of derivatives and leverage. Can you explain
in more detail?
Yes, we only borrow money to get over 1 or 2 day shortfalls;
1-2% maximum. The volatility of the underlying market
is pretty high, therefore, we do not need to leverage
our returns beyond that.
In terms of derivatives, we definitely like them as there
are lots of different things that we do. For instance,
we look at premium or discounts on warrants. Often, it
is cheaper to buy the warrants as compared to stocks and
that is what we are doing currently. Also, when a stock
has had a big run and the warrant is deep in the money,
we can take some of our invested capital off the table
by switching out of the stock and into warrants. This
increases leverage and reduces the total money at risk
because that money goes into cash. It allows us to maintain
exposure in the stock without tying up so much money.
Warrants are always less than 5-10% of our portfolio;
most of our returns come from selecting cheap stocks and
riding them up over the long term. We also do index swaps,
buy and write over-the-counter options as a way of protecting
- In the event of a general market rally, how much would
you generally increase in the number of derivative products
that you are using?
We would do so if we could find attractively priced
options. Generally, if there is a big surge in the market,
the volatility goes up, and the price of the option goes
up as well. We would generally want to buy options when
volatility and sentiments are low and sell them when people
- For a firm focusing on fundamental research-driven
stock selection, is it necessary to run a small fund in
order to remain flexible? How big will you allow yourselves
to grow to?
We have just changed the liquidity terms in our funds.
Up to $150 million, it has been reasonable to have a 1-month
notice period for people to redeem. Now, however, as we
are now at above $210 million, we must make liquidity
terms more restrictive. For assets between $150 to $250
million, the notice period is now 3 months. If we grow
to between $250 and $400 million, the reasonable notice
period would be 6 months.
Longer notice periods allow us to take even deeper positions
in our favourite stocks while controlling our liquidity
- Where are you currently situating the fund to make
profits over the winter months?
Since we have very few but big positions, we do not
typically position over the short term; we are thinking
more of the next 2 to 5 years. The current market environment
for equities is very good because we have falling interest
rates, good US GDP figures and Japan's recovery from economic
depression. It is very likely in the next year that we
will see Thailand's export sector getting its pricing
power back. Over the last 3 years, manufacturers were
running increasingly high capacity utilisation but at
the same time, they had very little pricing power; most
were running slightly better than breakeven. As the world
economy gets going again, Thai exporters start getting
their pricing power back, which will make them very profitable.
They have tremendous operating leverage to small increases
The drop in interest rates will continue to influence
domestic fixed income investors to take money out of the
bank (1% deposit rates) and invest in the stock market
where the yield is much higher (6% current yields).
- How would you characterise your investment style and
what is your edge?
Our investment style is bottom-up driven. We are looking
for cheap stocks which have low P/E, low enterprise values
to cash flows and/or have big discounts to our estimate
of their liquidation value. We also like stocks which
have high earnings growth.
Since we are the largest or the second largest shareholders
in the companies that we invest in, we have better access
to management than the average investor. Even in companies
where we are not on the board of directors, we have a
very close working relationship with the management team;
participating in the direction of growth.
- What have been the most difficult aspects in running
your own hedge fund?
Previously, I was running a family office doing very
much the same as what I am doing now. The most difficult
aspect was finding investors who were really interested
to invest in Thailand. I started off by doing personal
direct selling, reading up to find people who might be
interested. However, we found this to be very unproductive.
Basically, we want to find people who were already interested
to invest in Thailand and are looking for the best way
to invest. Now, we use third party marketers who already
have the relationship with clients. Through them, we can
screen out the potential investors. We can also increase
investor awareness of our service more efficiently through
conferences and in publications.
- Do you have any opinions on or plans to diversify into
We are aware of what is going on but are not experts
in markets other than Thailand. Although China is growing
and attracting a lot of the available investment dollars,
there are certain factors which make Thailand competitive
For example, the tourism sector. Every year for the past
35 years, there has been an increase in the number of
tourists to Thailand because tourists get excellent value
for dollar, good quality and excellent service. This offers
a great value of proposition for tourists, which produces
a lot of repeat business. The largest tourist group in
Thailand is now the Chinese as they now have enough money
to travel. Since Thailand is close to them and is similar
to Southern China, they get a great deal. The biggest
increase in Thailand's exports has also been to China,
which is buying not only raw materials but also value-added
finished goods for consumption by the domestic Chinese.
After Tiananmen Square and SARS, people are reluctant
to place all their eggs in the China basket even though
the huge domestic market is very attractive. Direct investors
find that, as an alternative source to China, Thailand
is very attractive.
Quest Management Inc
+66 2 652 2750