| Hedge Fund Monthly
Interview with Frank Brochin, General Partner,
New York-based StoneWater Capital is founded and run by a group of partners with significant public and private equity investment experience. Founded in 2004, StoneWater Capital is a specialised asset management firm and manages over US$150 million in a global family of long bias fund-of-hedge fund vehicles as well as custom vehicles and other investments.
- One of the common themes about
the StoneWater Capital partners is that
you all have private equity backgrounds.
Why get together and form a fund of hedge
We formed StoneWater Capital in early
2004, as a vehicle for investing our own
funds. As former partners of Warburg Pincus,
a leading, global private equity firm,
we understood the appreciation potential
of investing in private markets; at the
same time, we sought the liquidity provided
by public markets.
Hence, we set as a primary objective to
preserve and grow our capital by investing
in public markets through equity managers
who think and act like private equity
investors. We feel that over long
periods of time, such fundamental equity
investing-whether in the private or public
markets-is the most consistently successful
method for safely preserving capital and
generating substantial wealth.
To date, we have raised US$155 million,
which includes approximately US$30 million
of our own funds. We believe our firm
is distinct among fund-of-funds management
firms for its dedicated focus on long-term
- Why did you focus on Asia?
We believe that the emergence of Asia,
excluding Japan, presents the most compelling
investment opportunity of our time. Just
as technology was the driving macro factor
of the 1990s, the development of Asia
will be the most transformative macro-economic
event of this decade. The overall region
today resembles Japan in the early 1950s,
when the first farsighted investors recognised
that it offered a combination of high
growth prospects and low valuations that
were superior to any other market in the
world. From 1950 to 1972, Japan transformed
into a developed economy and early investors
made more than 50 times their money: we
feel that globalisation, both in terms
of technology transfer and large foreign
capital inflows, is likely to accelerate
the transformation of Asia in a shorter
time span than recorded in Japan.
- As a group you have a couple
of products-a US focused fund and an Asian-focused
fund; do you take the same approach for
We have the same approach in the US, where
we manage three funds. As a firm, our
sole focus is on long-term fundamental
managers. As former private equity investors,
the four of us have a significant competitive
advantage in sourcing, engaging, assessing,
monitoring and replacing fundamental managers.
- How much time do you spend looking
at or researching macro economic conditions?
We are not a macro fund; we make money
by picking bottom-up fundamental investors.
However, we believe that Asian growth
is fuelled by a variety of long-term macro
trends that are largely immutable, and
will create significant opportunities
for our managers and the businesses they
invest in. These include: (i) vast first-time
infrastructure building due to general
development and increased urbanisation;
(ii) a burgeoning middle class and resulting
growing consumer demand; (iii) favourable
demographics, as a large portion of the
Asian population is entering its middle-age
years, during which they are the most
productive from an economic perspective;
(iv) credit expansion among both consumers
and businesses; and finally (v) pan Asian
trade, now exceeding trade with the West
for many Asian countries.
The cumulative effect of all of these
factors is that Asian growth today is
self-generated; it is no longer export
- We have seen a number of groups
launch Asia-focused funds of funds, you
have a different approach to most in that
you invest solely in long-biased equity
managers. Is there a danger that you will
lose some diversification benefits and
your underlying managers will all go down
together in bad months?
We did a pro-forma analysis of the past
five years, which showed that our maximum
drawdown would have been less than one
fourth of the index maximum drawdown over
the same period.
One reason is that we are ideally structured
to deliver both alpha and limited risk:
our fund is made of concentrated portfolios
of misunderstood and under-researched
small- and mid-cap stocks, diversified
by industry and country. Since each manager
runs a concentrated portfolio, each manager
can deliver alpha while having a relatively
low correlation with other managers and
with the overall market indices.
Moreover, our managers are exceptional
investors who know how to pick stocks
that offer stable earnings and compelling
valuations, and thus have limited downside,
even in declining markets. Our private
equity background allows us to distinguish
between such exceptional fundamental managers
and investors who have merely been lucky
- What kind of sectors do you
We believe that the best strategy for
investing in Asia is to build a highly
diversified portfolio of stocks that will
benefit from the rise of the Asian middle
class: we call these consumer-oriented
This strategic choice translates into
a predominant focus on small- and mid-cap
companies, and into a competitive distinction
compared to most Asia-oriented mutual
funds and hedge funds, which offer a near-exclusive
exposure to large-capitalisation stocks.
Although larger stocks provide more liquidity,
in many cases they provide a volatile
earnings stream at fully valued prices.
In addition, most large-cap Asian stocks
are in highly competitive, international
industries, eg, exporters, industrial
companies and commodity manufacturers.
By contrast, most stocks selected by our
fundamental managers will have dominant
local market positions, strong operating
margins, positive cash flow, limited competition,
limited debt, rising P/E multiples, growing
liquidity and compelling valuations. This
approach should dampen both economic and
- You reviewed over 200 managers
as you carried out your research; what
are the criteria you look for?
We performed a year-long, exhaustive review
before launching our initial portfolio.
The identification of a handful of superior
companies and management teams from a
large universe of small- and mid-size
companies requires intensive research
and balanced judgment by exceptional fundamental
managers. Each of our managers has been
assessed to possess a first-rate intellect,
rigorous analytical discipline and deep
knowledge of indigenous business challenges
unique to specific industries in each
country and local market. Not surprisingly,
they have a long exposure to the Asian
equity markets, on average 18 years. With
two exceptions, all of them are based
- How receptive have your client
base been to the idea of an Asia-only
fund of funds?
Our clients agree with us that investing
in Asia today is analogous to investing
in the US at the onset of rapid industrial
expansion more than a hundred years ago:
opportunities abound, but one must be
selective. In that context, they appreciate
our focus on Asia.
- How would you define your approach
to risk management?
We focus on minimising business risk and
valuation risk by buying unique companies
at compelling prices; we do not focus
on minimising volatility. We accomplish
this by picking exceptional fundamental
We then seek to dampen volatility, as
compared to minimising it, by making sure
that our portfolio is diversified in terms
of managers (10+), companies (200+), industries
(15+) and countries (10+).
- How do you manage the relationship
between the liquidity you offer your own
investors with the range of liquidity
terms that your target managers put in
We are convinced that successful investing
in small- and mid-cap public stocks in
Asia requires a long-term perspective
and a private equity mentality, and we
encourage our clients to think and invest
for the long term.
We have a one-year lock-up for our Japan
and Asia ex-Japan funds (although liquidity
is available during that first year for
a 3% fee) and a two-year lock-up on our
Indian fund. This matches the underlying
liquidity of our managers.
- A lot has been written about
the recent growth of the Asian hedge fund
universe in terms of both assets and funds.
What positive and negative effects are
The growth of the Asian hedge fund industry
is a long-term positive for providing
additional liquidity to smaller stocks
and for our strategy. With more interest
in Asian markets, we would expect a re-rating
of the PE ratios of growing, smaller domestic-oriented
- What is your outlook for the
rest of 2005?
The MSCI Asia ex Japan index has outperformed
the US market in each of the last four
years; we would not be surprised if the
same occurred again in 2005.
However, we are long-term fundamental
investors by training; in fact, the four
of us collectively have some 80 years
of long-term fundamental investing experience.
We are more comfortable predicting the
next three to five years rather than the
next five months.
In the next three to five years, I expect
that our investors in Asia will benefit
from the triple upside of sustained rapid
earnings growth, major expansion of price/earnings
multiples, and significant currency revaluation.
I also expect that our fund will outperform
the MSCI Asia ex Japan Index, which should
in turn out perform the S&P 500 index.
Stonewater Capital LLC
1 212 207 5509
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