By James Williams – Start-up numbers in Hong Kong might be down, but their size and quality is improving.
As the gateway to China, Hong Kong is perfectly located to capitalise on the growing alternatives industry, which earlier this year surpassed its previous high-water mark to reach USD2.02trillion in global assets. One of the great things about Hong Kong is how convenient and efficient everything is. In what amounts to probably little more than two square miles, the city’s financial district, Central, contains the majority of hedge fund managers and service providers. If ever the term “community” was relevant, it’s here. This has helped generate a vibrant, dynamic and fresh investment industry.
Post ’08 the number of Hong Kong start-ups rose to around 70 in 2009, reaching a similar number in 2010, but things have slowed down slightly this year. ““Asia is on pace to see at least 50 start-ups again this year,” says Sukru Kesebi, Deutsche Bank’s Head of Hedge Fund Consulting, Asia Pacific. “There’s been a huge influx of talent into Asia. Over 20 large US and European fund managers have opened offices in Asia in the last two years with some launching Asian-dedicated products. We expect this trend to continue over the next several quarters."
Samena Capital is a Hong Kong-based hedge fund adviser, established in 2008 to focus on investment opportunities in the Subcontinent, Asia, Middle East and North Africa. Julius Wang heads up Samena Asia Managers, the firm’s seeding arm. He notes that right now Hong Kong is less competitive in terms of the number of managers available for seeding, but more competitive in terms of capturing new assets. “I would differentiate between the two when talking about competition here,” says Wang.
Five years ago, Hong Kong had one of the more tightly regulated regimes. Having never operated a funds business anywhere else, Wang is quick to stress that comparisons with Singapore or the US cannot be made, but admits: “There’s a lot of reporting requirements and ordinances that the SFC imposes on the industry. It’s quite burdensome. However, investors find this heightened regulatory regime to be a plus point so we’re glad it weeds out certain groups.”
A point that Andrew Gordon, head of BNY Mellon’s alternative and broker-dealer services, APAC, agrees with: “Fund managers know what they need to do to raise institutional assets. There are a number of funds that are focused on HNW individuals in HK but it’s generally recognised that institutional investors globally are playing a more important role in the industry, including Hong Kong so that’s where the larger managers are focusing.”
Like Kesebi, Gordon is seeing slightly lower numbers of start-ups “but the overall quality is much better”. This is because the overall talent pool is improving, with Kesebi noting a wave of second generation fund managers coming from prop desks and funds that have since been shuttered. "Although the average launch size for start-ups is lower in Asia then in other regions, we nevertheless expect to see four or five launches this year with greater then USD500million day 1 AUM,” says Kesebi.
“The pool of managers has deepened. We have a business where we seed hedge fund strategies and managers and we’ve seen the talent increase substantially,” adds Wang.
Oracle Capital launched its Caymans-domiciled fund last May. The firm chose to set up the business in Hong Kong because all the major service providers and intermediaries were based there. “Personally, as both my business partners and I were already based in Hong Kong prior to setting up the fund it was natural to set up here and maintain our existing network,” explains Oracle Partner, Fredric Teng.
As mentioned, Hong Kong’s location gives a critical advantage to managers focused on trading Asia’s capital markets. Although Samena also has an office in London, they chose to be in Hong Kong because of its proximity to China and its accessibility. “Many investors come through here on the way to China and vice-versa, so I think Hong Kong is a great nexus point. The number of meetings and impromptu get-togethers is conducive to working here,” says Wang.
When setting up the business, Oracle’s Teng found the SFC efficient and business-friendly. He attributes this to their “open attitude” to taking onboard advice and ideas from the fund management community. “Licensing requirements balance the need for investor safeguards whilst not making it too cumbersome for qualified individuals to operate a business,” comments Teng.
Oracle used Compliance Asia as its licensing and compliance counsel. The process was, in Teng’s opinion, extremely smooth. The fact that they had all the required documentation meant that getting licensed “took just a few weeks” from start to finish. “I would recommend any start-up funds to engage a professional firm to guide them through the process,” asserts Teng.
Unlike Singapore, all fund managers need to be SFC licensed: there is no test for exemptions. A clear investment strategy, the right experience and an appropriate infrastructure are pre-requisites: the latter being especially helpful when aiming to capture institutional assets. Additionally, a minimum of two Responsible Officers is needed. “Such quality control enhances the reputation of Hong Kong as a hedge fund centre,” opines Teng.
Gordon notes that as more institutions allocate to the region, hedge funds are using more independent services, in particular custodial services such as those provided by BNY Mellon. “We’re seeing strong demand on the custody side in response to institutional investors’ demands for asset protection,” says Gordon. “But it’s mainly the bigger fund managers that have the operational capability and infrastructure to make sure their assets are in the right place, and at the same time remain significant customers to their prime broker(s) – they can’t spread themselves too thinly.”
The problem, currently, is that whilst investor interest is high, it remains just that: interest. Ticket allocations are taking longer, and as Deutsche’s Kesebi notes: “Capital is scarce. However, large institutionals are increasing their portfolio exposure to Asia and we believe we’re on the cusp of more capital coming into the region.”
Wang agrees, noting that historically new assets came from Europe and the US “but that’s shifting now with the likes of CIC (China Investment Corporation). Many Asian countries have high savings rates and looking at a successful investing model like Singapore’s Temasek.”
With execution volumes down, where is the golden egg coming from for Hong Kong’s prime brokers? For Deutsche, Kesebi thinks, as in previous years, the lion’s share of revenue this year will come from synthetic financing to hedge funds trading restricted markets like India and China A, which often require them to use swaps. “Frontier markets like Pakistan, Sri Lanka, Vietnam and Bangladesh are becoming interesting to hedge funds as well,” Kesebi adds.
David Murphy, Deutsche’s Co-Head for Global Prime Finance, Asia, points out that whilst investor appetite for small funds was muted last year, “balance growth in Asia came primarily from large global funds increasing their capital allocations to the region. Much of this balance growth took the form of increased synthetic equity positions.”
Greater due diligence means that established funds being able to demonstrate to potential investors that they have global institutions with valued reputations supporting them is a big plus. But that doesn’t necessarily mean local start-ups are overlooked by the likes of BNY Mellon.
As Gordon explains: “We’re focused on high quality Asia-based funds and these have been successful this year. We like to help start-ups as some will go on to become industry leaders.” Picking those future leaders though is more art than science. “We look at a manager’s background and paint a picture but we haven’t got a crystal ball. Sometimes it works, sometimes it doesn’t.”
With global heavyweights rolling into the region, new or recently established hedge fund businesses like Oracle Capital have to work harder than ever to stand out from the crowd. This is good, as it’s pushing Hong Kong’s alternatives industry to the next level.
Oracle’s is the only fund, for example, dedicated to structured credit opportunities in APAC. YTD it has returned 20 per cent for its investors (70 per cent annualised for 2011). “New emerging funds have fresher ideas and I think having the founders’ own skin in the game is a big part of it,” says Teng. “Having high quality FoHF operators who are open-minded to new ideas is critical for the growth of our industry.”
As for where overall improvements could be made, Wang feels regulators could do a better job separating retail and professional investors. “I think fund advisors get the regulations a bit mixed up at times and that causes extra paperwork for hedge funds in the city,” says Wang.
Office rents are also far from ideal. Teng cites it as one of the hardest aspects of running a hedge fund business. “Hong Kong is shockingly overpriced and not very high quality. However, the easiest aspect is operating the business itself. All the service providers here are competitively priced. We outsource a lot of functions.”
“You’re just down the street for your service providers here, it’s a highly efficient place,” adds Wang.
According to Gordon there are over 25 fund administrators in the city. Recently, the prime brokerage space was a duopoly shared between Goldmans and Morgan Stanley but things have changed. Deutsche, along with UBS and Credit Suisse now have comparable market share. “A lot of new heads are being added to all the prime brokerage teams including ours. For us, recruiting five new heads by year-end would be ideal,” adds Kesebi.
UBS has revealed its expansion plans for the region. Over the coming months it intends to establish a business development and client service office in Hong Kong along with a full service administration centre in Singapore. Darren Stainrod will head up the APAC Fund Services unit whilst Michael Moore will take charge of the operational setup in Singapore.
“We see good potential and we’re delighted to be located here versus other locations. The decision has paid off,” concludes Wang.
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