QUAD Capital Management (QCM) was set up in Hong Kong in February 2014 as a subsidiary of QUAD Investment Management (QIM) based in Seoul. QIM, which runs US$2.5 billion AUM, had a vision, from its beginning back in 2010, to go beyond Korea in terms of investment geography as well as capital raising. QCM is the firm’s frontier to achieve this goal and currently manages QUAD’s three offshore funds of which QUAD Asia Absolvt Fund is the firm’s flagship fund. HK Choi runs QCM as CEO of the firm while managing QUAD Asia Absolvt Fund as CIO. He has total of 17 years investment experiences of which six years are in distressed debt and private equity investment followed by 11 years in public equity hedge fund industry including six years at Eton Park.
- Please share with our readers a bit of background on the QUAD Asia Absolvt Fund, the type of investors you cater to and your overall investment philosophy.
QUAD Asia Absolvt Fund was launched in November 2014 after we successfully ran clients’ money under several managed accounts. The fund’s strategy is a fundamental, equity long short fund with a market neutral (low net) mandate. We primarily invest in three Northeast Asian markets (Greater China, Japan and Korea) which are basically our team members’ home countries. These three countries are closely linked either by competition or supply chain. We tend to find many investment synergies while covering these countries together.
We have a rather large team of 22 investment professionals spread across both our Seoul and Hong Kong offices. Hong Kong team members are country specialist while Seoul office team members are sector specialists. We work together as one team under a matrix research system to achieve our investment philosophy of ‘Thinking globally while acting locally’. (Thank you HSBC.) We don’t have an office presence in the United States or Europe, however our team members frequently travel to western countries to attend industry conferences and to meet experts and company representatives. We do not believe we can predict the future accurately all the time, but we do believe we can generate alpha with high correlation to the amount of sweat and hard work we dedicate to our research, and believe that protecting client’s assets by diligently following up to make smart decisions when market dislocation exists, will pay off in the end.
Our target investors are those who look for medium risk/return profile with low net exposure to markets. Our aim is to deliver uncorrelated returns with the markets we invest in, with our fund’s actual correlation with MSCI AC Asia index being 0.1 since inception.
- Unlike most Asian hedge funds with an equity long-bias mandate, QUAD Asia Absolvt Fund has an equity market neutral strategy. What are the merits of undertaking such a strategy?
Our investment objective is to achieve absolute returns regardless of market direction and naturally this goal dictates we take a market neutral approach to investing (very low net exposure to each country as well as each industry).
Along with each of our team member’s prior industry expertise, high team spirit and disciplined investment approach, we think we have been able to achieve the alpha returns by maintaining our approach, and we hope to continue to do so.
- We understand that the QUAD Asia Absolvt Fund has an objective of 15%+ return (net of fees) with a less than 15% volatility. How do you arrive at this figure, and can you tell us more about fund’s risk management process in ensuring that the fund’s portfolio meets the target volatility?
When we launched our fund, we set a 15% target return while controlling volatility within 10% to 15% (which implies our target sharp ratio is 1.0 to 1.5) as we thought this was the medium risk and return profile range that investors wanted, and we thought we could deliver.
We keep track of the fund’s daily realised volatility (one and three months on a rolling basis) as well as the expected volatility driven by our risk model. We control our volatility mainly by managing the fund’s gross exposure. So far, we have been able to enjoy the fund’s volatility between 10% to 12% when we keep gross exposure at 250%. For risk management purposes, we have 12 hard risk management parameters (e.g. single stock stop loss rule) and seven soft risk management parameters (such as VaR Limit) which is monitored daily by both the PM and our risk managers.
- 4. QUAD Asia Absolvt Fund returned an impressive 26.74% in 2015, outperforming the Eurekahedge Asian Hedge Fund Index which was up 6.46%. What were the main themes supporting your outperformance during the year?
We try to remain sensitive towards structural changes that occur either at the company or industry level and select the best beneficiaries as long investments and worst victims as short. We then perform in-depth analysis of the full value chain, that gives us confidence and conviction on our investments.
One of the themes we identified in 2015, earlier than the market, was the strong growth in Chinese inbound travellers to Japan as we have observed such phenomena in Korea from 2013 onwards. We took long positions in those companies who would enjoy this structural and sustainable earnings growth such as cosmetics while shorting the over hyped companies (at a later date) which we determined will not have actual benefits to their earnings.
Other structural changes we identified in 2015 were the 1) new 3D NAND investment cycle, the 2) penetration of a wider range of new smart watch models released and the 3) Japanese labour market deregulation which worked to help some of the Japanese labour outsourcing related companies.
We were also active in taking long and short positions based on consumption behavioural changes by the Chinese within each consumer product group such as food & beverage, baby product and leisure spending.
- As a fund which allocates considerably into Northeast Asia (75%), what are some examples of the sectors within Northeast Asia which your fund focuses on, and why?
We invest in broad industry groups in Asia but focus more on three sectors which are IT, consumer (discretionary and staples) and biotechnology/healthcare. We believe these three sectors provide more bottom-up investment opportunities than the other sectors such as industrials, energy and financials which are more influenced by the macro-economic factors.
- Do you maintain any target ratios across different sectors, for example 40% consumer, 20% financials and so on? How do you determine your allocation within sectors?
We don’t have any specific target allocation ratio for each sector. Instead, we make decisions on fund capital allocation mainly based on three risk/return profiles on each position (i.e. upside potential, level of conviction and target investment horizon). What drives this process is our bottom up portfolio construction process but we finish the overall portfolio construction by ‘neutralising’ each sector’s net exposure. However, historically, we have allocated about 30% in IT, 30% in consumer and 15% in bio/healthcare (collectively 75% in these three main sectors) for our portfolio.
- How many stocks on average do you hold and how frequently are you shifting your exposure between country/sector combinations?
- Understandably, Northeast Asia has a large and demographically diverse consumer market - what are some of the upcoming trends you anticipate within Northeast Asian economies? In particular, how do you view the prospects of consumer cyclicals in the context of China?
- Your fund was up an impressive 7% in the 3-month period ending August 2015 when the Chinese equity markets crashed, but was quick to give away these gains in the following two months when markets had begun to recover and the average Asian hedge fund was performing well. Could you run us through these events and what went right and what went wrong?
- What is your outlook on the equity markets going into Q4 2016, specifically, how is your portfolio positioned in light of the policy divergence between the US and Japan?
- Given the pickup in the pace of investor redemptions, what do you make of current investor sentiments? What kind of investors have you seen the most interest from in the past 12 months?
- Lastly, please share with our readers your medium-term outlook for the overall market. Which regions are you more bullish on, and how do you plan to reflect this into your allocation in the portfolio?
We hold about 150 to 200 stock names in our portfolio. The number of stocks would look high compared to the peer group average however all the stocks are selected after our in-house proprietary in-depth research process followed by rigorous internal discussions.
Our sector and country allocation has been relatively stable although we actively manage single stock exposure in order to react to the market situations whenever necessary, for risk management purpose.
Following the Chinese, Japanese and Korean consumer behaviour is a very interesting research topic as some aspects are very similar to one another, while others are totally different.
Korea and Chinese demographics trend follows Japan’s in terms of increasing single man or woman households, increasing part-time working jobs and an aging population. Convenience stores would be one of the beneficiaries from this trend.
Specifically on China, we have observed the upgrade on spending in many consumption segments such as education, travel, sports and entertainment. Gym memberships have become one of the hottest growth areas these days. Young Chinese consumers care more about ‘total experience’ than just buying things on the cheap.
China became the largest e-commerce market in the world. The online platform is still opening up new opportunities to sellers as well as buyers. Cross border e-commerce opened doors for many international products. Brands which previously benefited from good offline distribution channels are now penalised while other new brands penetrating the market making the best use of this new online distribution channels are taking market share. Not only imports but also exports of consumer products are also picking up via cross boarder E-commerce. Apps such as WeChat and Taobao are gaining popularity overseas. Consumer electronics such as smartphones and drones are also gaining international market presence.
Our fund has kept an almost net zero exposure throughout, so quite simply, the poor performance was not because of market direction but our stock selection during that period. For example, we took shorts in the smartphone value chain as we believed, after our in-depth research, that the smartphone market already passed the growth inflection point from the middle of 2015 and that the industry growth rate will be at best 5% going forward. Our view was, at that time, out of consensus as the market was still expecting double digit growth. We took short positions in early September 2015 but those stocks went up higher than the market during the following two months along with market recovery, hurting our fund. We trimmed our short positions to reduce the risk. These positions eventually began to work out from November 2015 contributing to the turnaround of the fund from November onwards. We were particularly lucky in early 2016, as our smartphone value chain shorts helped with performance during January 2016, helping us to finish with a 3.7% gain that month.
The Market has been dwelling on the Fed tightening and BOJ printing money for quite some time already, so I believe most of those highly anticipated policies have been reflected by the market. Maybe a one or two day event for market’s when those events do occur.
We do not think it is our business to guess the direction of the market, but I would say we are cautiously optimistic about the overall equity markets despite the anticipated Fed rate hike simply because there is still too much liquidity in the system which can’t go away with only a 25bp or 50bp rate hike. In terms of corporate earnings in Asia, we expect to continuously see more revision up than down, which is another positive indicator.
Regardless of whether we are positive or negative about the market, we will keep our fund net exposure low to hedge out the market, sector and factor risk as much as possible. We think our business is a highly labour intensive business, where you have to be diligent in the work you do, so you can be rest assured that we will continue to ‘hustle’ from the ground up to find the next diamond in the rough, which will lead to us producing alpha ideas.
Asian strategies in particular have been under the gun as their outperformance reversed in 2015. This larger trend has affected our potential investor base negatively as some have retrenched their Asian investments this year. Despite that, we have been receiving continued queries from investors who have been inquiring about our low net strategy as being unique to fundamental investing. Our battle has been more about the fact that we remain a new name in the fund raising world, despite QIM having established itself in Korea with US$2.5 billion under our belts. Early investors would have heard of us from early last year, but majority would have started to hear about QUAD from late 2015 onwards.
We continue to be engaged in dialogue with some of the big endowments, foundations, family offices, and some of the largest fund of funds.
I do not presume to have much capability in forecasting which markets will perform better than others in terms of equity index performance, so let me rather briefly talk about the investment opportunities in the region. In terms of the IT sector, we believe 2016 marks the beginning year where we transition from rigid LCD’s to flexible OLED’s in the consumer display panel market. We think those companies that have a competitive edge would enjoy ample growth over the next several years. There will bound to be companies that also lose out from this transition, which we hope to benefit from as well.
ADAS and Autonomous driving is no longer a dream but is something closer to reality. The regulation changes and government support is hastening in this new era, and despite the difficulties this industry invariably faces, it will also overcome them. We are trying our best to come to grasps with winners and losers from this big trend taking place, in both the automobile, IT and internet space plus other areas that could potentially benefit.
Athleisure is another mega consumption trend in Asia which we are studying diligently. We are following the value chain which supply their manufacturing services to Nike and Adidas for starters.