New opportunities for Hong Kong managers as China liberalises capital markets
By James Williams – Athos Capital is a new merger arbitrage hedge fund founded by portfolio manager Matt Moskey, trader Erik Senko and former COO of Black’s Link Capital, Fred Schulte-Hillen. Moskey and Senko previously ran an Asian product under Tiresias Capital Hong Kong Ltd; a subsidiary of event-driven firm Omni Partners. Prior to that, in 2007, the pair opened up the Asian office for London-based Centaurus Capital.
Thanks to the principals’ pedigree, Athos Capital had no trouble choosing their prime brokers. Speaking on condition of anonymity, a source familiar with Athos confirms that both Goldmans and Morgan Stanley were selected. The decision to set-up in Hong Kong was basically down to the fact that the fund strategy only trades the Asia Pacific markets. The principals like the fact that Hong Kong has a “proper grown-up regulatory environment and a high degree of predictability, as well as a sophisticated network of service providers”.
Within the overall event-driven space, which in Asia is dominated by funds like Nick Taylor’s USD1billion Senrigan Capital, Athos Capital offer a niche product, with the source confirming that the firm is “primarily focused on hard catalyst events. It’s essentially a risk arbitrage fund and likely to be exclusively so during periods of market dislocation. The strategy looks to create an uncorrelated independent income stream out of the risk arbitrage opportunity set in Asia.”
Most smaller event-driven funds in Asia are skewed towards softer catalyst opportunities: the firms that tend to really focus on risk arbitrage in Asia are global funds looking to deploy assets to the region. Because of their size, however, they tend to be limited to the biggest and most liquid deals where spreads tend to be tight.
According to the source: “A strategy like Athos Capital’s is more likely to sit short on a 2 per cent crowded spread with a long payment date because they know the chance of interim negative news flow blowing that up to 3 or 4 per cent for short periods of time is much higher than remaining at 2 per cent for the next five months.” Being small and nimble is advantageous because you can focus on generating alpha from smaller mid-cap deals that a USD2billion fund cannot consider.
Hard catalyst events include deal announcements and general M&A activity as opposed to soft events that include restructurings. These strategies typically hold positions for six to 18 months and tend to be more highly correlated to the markets. Athos Capital’s approach is to build M&A positions with 80 per cent of the book turning over every four weeks.
“The strategy’s biggest markets are Australia, Japan, Hong Kong, Singapore, Taiwan and Korea. Second-tier markets include less-developed markets like Malaysia, Thailand, Indonesia, as well as India,” confirms the source.
The deal with Ascalon Capital is not a seeding arrangement per se but more a strategic partnership. Seed capital is good for new managers but what it means is they haemorrhage money as they build AUM; depending on the arrangement, a seed investor may take as much as 30 to 40 per cent top-line revenue until a break-even point is reached.
But Athos Capital, according to the source, does not have the pressure of aggressively raising assets to get to break-even point as quick as possible as the deal itself is two-fold. Firstly, they allocated full fee-paying capital into the fund. Second, they bought a 35 per cent equity stake in the management company.
“The way the deal was priced was based off of three years’ working capital. What that means is that for the next three years they don’t have to worry about their break-even point and be forced to travel to Europe and the US raising assets each month. The deal gives them a good runway to replicate the performance achieved in the past: which is really the best fund raising tool at their disposal,” says the source.
One manager that has been keeping a low profile on the capital raising front is Joe Chan’s Galaxy Asset Management.
“Last year’s performance in our Galaxy China Opportunities fund was not that strong. However, I have noticed a lot of investor interest in China-focused managers, maybe not direct investment into a fund vehicle but more through separate mandates. Whilst we haven’t taken any on managed accounts in any major way, we’ve had a lot of discussions with prospective clients,” confirms Johnson Cheung, chief economist and strategist at Galaxy.
Joe Chan (pictured), the firm’s founder and CIO, adds that interest has also been building in the firm’s Galaxy China Deep Value fund which launched after the financial crisis in 2008: “Post 2008 investors wanted something unique and different. The fund was down 4.5 per cent in 2011 but since inception it has generated net annualised returns of 62 per cent.”
The fund looks to exploit mis-pricings and undervalued securities in Chinese companies in the Greater China region (China, Hong Kong, Taiwan) but according to Chan it is capacity constrained: “I’d say the fund’s AUM ceiling is USD300million.”
Likewise, being a niche strategy, Athos Capital’s fund is also capacity constrained: current projections suggest that it cannot be bigger than USD600million.
As for where the market opportunities were last year in the firm’s flagship Galaxy China Opportunities fund, an equity long/short strategy, Cheung says that one of the best performing sectors was the gaming sector, in particular Macao gaming. “Last year gaming revenues rose about 30 to 40 per cent. We had a profitable position in Galaxy Entertainment who had a successful casino opening last year, and a position in Sands that did well also.
“For 2012, the main opportunities we see are in fixed asset investment-related sectors. China still has a 7.6 per cent growth GDP target for 2012 at a time when international trade is slowing down. The only way that China can meet that target is by stimulating its infrastructure building. We’re therefore focusing on companies involved in the build-out of China’s railway network,” confirms Cheung.
Chan says they also like property companies, a sector that he says has been in the doldrums for some time. “Government policies popped the property bubble but we don’t think there’ll be further tightening. We expect the sector to recuperate. Share prices are still cheap: some of these companies are trading at 50 per cent discount to NAV with PE of about 5 to 6 times. It’s definitely a sector that we like.”
As is symptomatic of most hedge funds currently, Galaxy’s China Opportunities fund uses moderate leverage – about 1.3x. However, net exposure in the fund has increased to 50 per cent having fallen as low as 25 per cent in recent weeks with Cheung confirming: “The market has good value this year and we want positions that have more exposure although we’re reluctant to increase it further given what’s happening in Europe.”
The fund’s long positions in heavy machinery, railway stocks and China property stocks are offset with short positions in department stores and commodity-related stocks.
For Athos Capital, the M&A space in Asia presents far more opportunities than in the West which has a more unified set of M&A drivers: either there’s a lot of activity going on, or none at all. That’s not the case for Asia. The source familiar with matters at Athos Capital confirms that Japan is a particularly well-favoured market for the fund’s strategy where a lot of deals often close.
Another key market is China and Australia, with Chinese resource acquisition pushing mainland companies to acquire Australian coal firms, and other raw material producers. Southeast Asia is the third market, and finally India.
There are two key developments happening in China that could present a goldmine of opportunities for hedge funds going forward; although it should be stressed that initially, it’ll be the global heavyweights that benefit.
The first is a potential lowering of criteria to qualify for China’s Qualified Foreign Institutional Investor license (QFII), which allows foreigners to buy Chinese ‘A’ shares. Currently, the minimum criteria are for an institution to hold at least USD5billion in AUM and have been in business for at least five years.
The CSRC are deciding whether to soften their stance in order to diversify the types of investors holding a QFII license. This would be good news for US global hedge funds like Bridgewater and Citadel, but even if the QFII criteria were to fall to say USD3billion, this would still rule out most Asian hedge funds; at least initially.
It should be stressed, however, that nothing concrete has been decided. Hedge funders still have to rely on the prime brokers who use their own QFII quotas to purchase stocks and bonds on their behalf. “The Chinese like to make sure they understand what they’re doing and when they become more comfortable with it they expand it and I think that’s a smart way of developing the market,” comments Ascalon Capital’s Chuak Chan.
“It’s all positive news. There are no immediate opportunities but things are moving in the direction and we’ll certainly be keeping a close eye on how things develop,” says DragonBack Capital’s Phil Tye.
The second key development is the launch of a Qualified Domestic Limited Partner (QDLP) trial programme by Shanghai municipal government. This would allow limited partners to raise RMB from domestic investors and invest those assets globally. The initial quota is believed to be USD5billion. Once the CSRC are comfortable with the idea, the potential for global hedge funds to tap into China’s vast domestic savings will be enormous.
“China is liberalising its investment policies very quickly such as encouraging hedge funds in Shanghai through this QDLP scheme, all of which is tremendously encouraging for the future. However, it’s only open to the largest hedge funds – it’s a start but it doesn’t bring relief to the mid-sized mass market as far as hedge funds are concerned,” says Paul Smith of AGS Capital Partners.
As Rolfe Hayden, Simmons & Simmons, comments: “The ability to raise funds in China is on everybody’s mind but at the moment as the law stands it’s very difficult for a hedge fund to raise any sort of money in China other than from Sovereign Wealth Funds, and I don’t think that’s going to change any time soon.”
“Given the amount of wealth that’s expected to accumulate in China, we think it will be a huge opportunity for global fund managers to raise money from Chinese domestic investors for overseas investment. Our team in Shanghai is working closely with many fund groups and regulators to help structure these vehicles,” confirms Ernst & Young’s George Saffayeh.
If successful, the QDLP scheme will dramatically widen the scope for local Asian investment into hedge funds. This, in Smith’s opinion, is vital for Asia’s hedge fund industry to develop.
“More China HNWIs, institutions etc are allocating an increasing pool of money into the hedge fund industry. That’s only going to grow over the years. It’s a self-feeding virtuous circle: as the money comes in to the market, more managers will also come in to the market.
“It might take five years before they start backing smaller managers, but it’s going to happen and it’s going to be exciting when it does. I think it might coincide with the end of the deleveraging cycle as well.”
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