By James Williams – The average hedge fund was up 6 per cent through April and whilst the de-coupling argument largely holds up well for the Asia region, recent events in Europe have nevertheless had some ripple effect. Whenever macro stories come to the fore, correlations increase across all major assets and hedge fund performance tends to drop off.
“That’s especially true in Asia,” comments Graham Seaton (pictued), Head of APAC Prime Brokerage at Bank of America Merrill Lynch, from the firm’s Hong Kong office. “Recent macro developments have meant that along with fundamental strategies such as long/short equity, some relative value strategies have also suffered because of the degree of intra-asset class correlation.”
Seaton says that 2012 had seen the return of event-driven and LSE strategies until May. Managers who switched their net exposures early in the year have done well whereas others missed the beta and have lagged quite heavily. “Over the last month it’s reversed again; macro factors have re-emerged, correlations have increased and performance in fundamental-driven strategies is falling off,” says Seaton.
The ability to build traction and generate performance, particularly for Hong Kong’s smaller managers and start-ups, is frustratingly tough in this continued risk on/risk off environment. On the one hand they need to grow assets to appeal to institutional investors. On the other they’re having to micro-manage exposure and leverage levels and, having learnt the lessons of 2008 when a number of managers were so net directional they may as well have been mutual funds, exercise restraint to avoid blowing up; thereby holding back performance.
Tim Wannenmacher, UBS Head of Prime Services, Asia Pacific, notes that one emerging trend is the recognition that even when global markets improve, if investors want high net exposure to certain markets, why would they invest in a hedge fund versus a long-only product? “Broadly, most hedge funds will move towards lower net exposure, lower volatility and long-term outperformance of market indices,” says Wannenmacher. He adds that at the beginning of May net exposure had already dropped to 25 per cent but has since fallen to around 10 per cent, with gross leverage at around 140 per cent reflecting the currently difficult market conditions.
Chuak Chan is the COO of Ascalon Capital Managers (Hong Kong) Ltd, a subsidiary of Australian bank Westpac. The firm takes equity stakes in some of the region’s leading boutique managers, the most recent being Athos Capital, a Hong Kong hard catalyst event-driven fund. Chan says that the seeding environment remains “quite tight” and that whilst deals are being done there haven’t been that many over the last six months.
“It’s tight and will continue to be for some time yet. The industry continues to be capital constrained but there are still opportunities for good managers. The days of a manager launching with investors clambering to invest have gone,” says Chan.
Global deleveraging combined with investor preference for larger branded managers is a fact that smaller managers, who continue to dominate the Hong Kong landscape, have to deal with. In Chan’s view, they need to be open-minded when starting up. “It’s rare for us to go into a meeting and have someone say ‘I think I’ll do it myself’ because even if you can get started it’s still difficult to raise money. It’s not just seeding; the whole capital raising environment right now is difficult.”
Paul Smith is co-founder of AGS Capital Partners (and founder of Triple A Partners), a firm advising non-Asian family offices on Asian hedge fund investment opportunities. In his opinion, whereas the seeding business five years ago might have resulted in a one-in-five chance of backing a successful manager, “now it’s probably more like a one-in-fifteen shot. It would be great to see some of those smaller managers thrive and survive but against the current backdrop I just don’t see how it can happen.”
Amsterdam-based seeding platform IMQubator has developed a joint venture with Hong Kong FoHF firm, Synergy Fund Management, to source the next generation of talent. Smith is all in favour of such developments but adds: “It would be stupid to say you can’t grow a USD30million fund because you can, but the problem is your chances of doing so are a lot worse now than they were five years ago.”
Fund of funds have long been key investors in hedge funds but faced with continued criticism over costs and performance the industry has been in freefall post-08.
On 21 May it was announced that Man Group Plc was acquiring well-established FoHF firm FRM, two years after it had bought GLG Partners. Consolidation is also happening in Asia.
In early May, Gottex Fund Management (Hong Kong) Ltd announced the successful acquisition of Hong Kong-based Penjing Asset Management, which runs USD434million in assets. With around 20 people and close to USD800million in AUM allocated to the region, Gottex now has one of the largest FoHF infrastructures in Asia.
“We have a strong product offering for global institutions seeking exposure into Asia,” says Max Gottschalk, co-founder of Gottex and head of Asia Pacific. “It’s an exciting step for us in Asia in terms of establishing ourselves as a key player and puts us in a good position to compete for institutional mandates from investors seeking to gain exposure to Asia.”
Gottschalk notes that like the rest of the world, overall investor interest has been relatively limited this year. “We’re not seeing huge inflows into hedge funds or FoHFs globally but I would say Asia is one of the best opportunities right now in terms of future allocations to the alternatives asset class.
“There have been a handful of mandates coming out of Japan, Korea and China looking at Asia-specific managers. Where we see real interest is from global institutions like US and European pension plans who are hiring people here in Asia and actively deploying capital – there’s been an increased level of interest over the last few months.”
One of the challenges in Asia is that you need funds of sufficient scale for large institutions to allocate to, according to Chan.
“Larger funds have a natural advantage in terms of attracting assets but people still want performance. If a small manager performs well and has a strong investment proposition, it will have a good chance of raising money,” says Chan.
Smith thinks the situation of larger funds attracting assets is even more extreme in Asia than elsewhere because many of the equity-based strategies aren’t scalable. “If you can get to USD200million you can grow quickly but to get there remains a real problem. The root of the problem is the banking crisis; because of global deleveraging there isn’t money in the system trickling through to financial products.
“Until the deleveraging cycle is concluded, which may be another five years away, I don’t see the situation changing. Smaller managers have got a long hard road ahead of them.”
Indeed, just this week Reuters reported that former Lehman Brothers trader Allan Bedwick was shutting his USD120million global macro fund because the fund couldn’t attract enough capital, despite making money for its investors. Firms like Doric Capital and Boyer Allan have also shut funds in recent times.
BAML’s Seaton says that four strategies seem to be ‘in vogue’ right now, in particular macro strategies with an Asia bias; especially those with a shorter term trading outlook. China long/short managers have also attracted inflows “because some are quite nimble and flexible in terms of their beta exposures, with net exposures being actively changed”, states Seaton, adding that for similar reasons Japan long/short managers have also attracted inflows.
Other strategies gaining popularity are credit and mixed credit/equity strategies, which ties in to Smith’s earlier point about global deleveraging. “There are opportunities to buy credit assets from banks and to operate in private lending situations. This is attracting a fair amount of sophisticated money, such as investors who have a deep understanding of various liquidity scenarios and are comfortable with longer term investment structures,” comments Seaton.
Harvey Twomey, head of global prime finance distribution for Asia Pacific at Deutsche Bank, admits that Asian credit markets haven’t evolved at the same pace as equity-based strategies. “However, this is slowly changing. The use of debt instruments by Chinese enterprises as a financing tool will increase and the offshoring of the Renminbi will present opportunities.”
Adds Wannenmacher: “Across strategies it’s been a tough environment in which to make money the last few months but multi-strategy and macro funds are holding up better than others.”
Gottschalk confirms that Gottex’s Asia FoHFs – Gottex Tiger Fund – has reduced the number of underlying managers from 40 to around 20 to create a more concentrated portfolio. He believes investors looking at Asia want “punchier products with higher volatility so running a more concentrated portfolio makes sense”.
He echoes Seaton’s earlier point by adding: “We’re looking for good China l/s managers, good Japan l/s managers: those are areas we’re looking to allocate capital into. We’re also looking at the macro space.”
Although a record number of Asian funds closed last year and nearly 40 have closed in 2012 there were some high profile launches such as Carl Huttenlocher’s Myriad Asset Management. This year looks equally as strong.
Former Lone Pine executive Eashwar Krishnan is launching Tybourne Capital, former Nomura Holdings Inc trader Benjamin Fuchs’s BFAM Partners (Hong Kong) is set to commence trading 1 June with a target AUM of USD500million, whilst Alp Ercil, the former Asia head of Perry Capital, has raised USD440million for a private equity-style hedge fund.
When asked why Ascalon had chosen to partner with Athos Capital, Chan responds: “Because, in a nutshell, they’re exceptional. We partner with managers based on three key criteria: the people, a strong investment strategy and risk management infrastructure, and a liquid strategy that doesn’t compete with our existing partners. Athos met those criteria. We want to work with exceptional managers and have total alignment with their interests so I’m not about to go out and look for another merger arbitrage fund (like Athos).”
Hong Kong is, and will continue to benefit from, second-generation fund managers with first generation hedge fund training like Athos Capital. Last notes that people “are buoyant that the industry here will grow over the next few years”, but adds the following caveat: “The backdrop to that, however, is that managers clearly face challenges; primarily increased regulation.”
Says Twomey: “An increasing number of global-calibre hedge fund launches are happening in the region. We believe Asia will see its first USD10billion fund in the not-too-distant future.”
Gottschalk thinks that given the fragmented nature of the industry it makes sense for smaller managers to try and secure FoHF capital. He also thinks that as Asia’s capital markets aren’t as well developed as those in the west, hedge fund managers find it harder to grow. “Those that have, by and large, have underperformed their benchmark. The real alpha for investors is in smaller local managers who are harder to find so having a strong on-the-ground presence, sourcing these investments, is important.
“The quality of talent here is improving and I expect that to continue as more capital flows into the region.”
That start-ups need to up their game, operationally-speaking, is good news for prime brokers keen to offer advice and assistance. Traders coming out of prop desks and larger hedge funds may not appreciate what’s required and “need a lot of hand holding” in Seaton’s view.
“We are seeing increased sophistication in how funds structure themselves. This is an area of growing importance from a hedge fund consulting perspective and we’ve made a dedicated effort to strengthen our platform by hiring a senior investment funds counsel from Sidley Austin. They will advise on details of fund formation, structuring of fund platforms, liquidity terms, investor due diligence, lock-ups and both hard and soft fund wind downs.”
The problem primes face is that not only are trading volumes and leverage levels down; at the same time banks themselves are coming under pressure to strengthen their balance sheets under Basel III. But there are ways to evolve. Hedge funds are increasingly trading more geographies, and across different asset classes, and this is actually helping brokers diversify their book of business.
Confirms Seaton: “There are three ways in which this is driving change in the business we’re doing: we are focusing more broadly on different strategies; we are seeking out launches focused on different strategies, and we are supporting clients as they seek opportunities in other asset classes. We have gained significant traction in this area, in part because of our integrated cross-asset margining capabilities and because of how integrated our business is across multiple product lines – these are clear differentiators for us.”
Wannenmacher believes that in order to defend and grow market position a prime broker has to be fully integrated with the rest of the franchise. “You can’t be a provider of one service only to the client. Capital introduction remains a key service. Clients want to know that you have access to differentiated pools of assets: we do, but also work closely with other divisions like UBS Wealth Management. From a capital introduction perspective, that helps,” says Wannenmacher.
He says that funding and counterparty considerations are key when choosing a prime broker: it’s “critical” that clients know they can be funded today, tomorrow, next quarter, in difficult market conditions “within a reliable and stable framework”.
“Other important points to consider are the quality of research provided, the execution quality, sales coverage and the relationship with investment banking. If you don’t have a strong offering in all those buckets, it’s very hard to compete in this business. They’re crucial in terms of how you grow market share,” says Wannenmacher.
Reflecting on how investors should view Hong Kong’s hedge fund industry, Smith says: “There are plenty of good small- to mid-size managers to invest in; there’s never been a better breadth of strategies in Asia. However, if you’re looking to invest in managers with USD500million and a 10-year track record, you’re destined to be disappointed.”