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Hedge Funds in Asia

Monday, July 30, 2007

Sub-Prime Disease Hits Asia

"For there is no defense for a man who, in the excess of his wealth, has kicked the great altar of Justice out of sight."

Aeschylus, Greek poet, 525 BC

Reports that the once highly-regarded US$1 billion Basis Capital has suspended investor withdrawals in early July due to the now spreading sub-prime situation hitting a good portion of their hedge fund investments sent concerned rumblings throughout boardrooms in Asia. This followed another Australia-based hedge fund that fell foul of the same U.S. sub-prime exposure, Absolute Capital, which had around US$175 million.

Further damage is likely to impact many Asia-dedicated fund of hedge funds that almost certainly had exposure to Basis Capital. There are approximately 120 of such so-called Asia dedicated fund of hedge funds so the recent downturn combined with ongoing performance issues related to Japan would almost certainly have offered yet another "black eye" for their investment performance heading into 2H07. Focus here might be on those products with small AUM and concentrated exposures to underlying managers. Watch out!

Not only hedge funds, but also some of the region's banks and brokers been forced to write-down exposure to U.S. sub-prime assets (Nomura to the tune of US$260 million). Almost certainly, there are other Japanese banks and brokers impacted too.

Not only that but a number of Japanese financial institutions are believed to have expanded their portfolio exposure through various CDOs structures in the chase for yield. Apparently the sum might be as high as US$8.3 billion which is frighteningly big. It will be interesting to see how some of the stock prices of many of these publically traded firms will react going forward.

Yes, we all know that sub-prime mortgages comprise only 14% of total mortgages and we all know that mortgage deliquencies are rising but what we don't know is the manner in which investors have exposure (either direct or indirect) into assets whose performance is tied to the returns of many of these essentially poor-credit loans. The fact that many of these pooled vehicles were "rated" made them all the more enticing. Who said that the Savings and Loans type historical mis-step could not repeat itself?

As ever, this developing situation highlights yet again the challenges involved in the due diligence process to understand fully the risks involved in investing, even if the negative situaion originated on the other side of the world. This is not just a hedge fund issue.
Mahalo.

Thursday, July 19, 2007

Japanese Broker Eyes Hedge Fund Platform

"The basic difference between an ordinary person and a warrior is that a warrior takes everything as a challenge while an ordinary person takes everything as a blessing or a curse".

Carlos Castaneda, 1925-98, Peruvian-born American author

The big news of the summer is likely to be talk that Nomura is looking to buy HFR's asset management platform. The move would put Nomura well ahead of its peers (Nikko and Daiwa) in expanding its business footprint in the hedge fund business.

The rationale is clear - there has been a perceived "dip" in demand for hedge find product from financial institutions in Japan over the last 24 months based upon rule changes affecting banks and related to Basel II capital requirements (see "Understanding Basel II" April 9, 2007 blog).

Perceptions are big, and particularly in Japan. There, it is felt that offering investment opportunities into an array of managed accounts (via some form of Cayman SPC vehicle) will address some of the investor concerns regarding transparency.

Presumably, investors will have some access to real-time transparency. This in turn, should enable shops like Nomura better sell products to Japanese regional banks and the like. It should also help Nomura get back into prominence after a rumored US$2-3 billion of assets were redeemed by its investors over the last few years either due to poor performance, high fees or other negative related issues. Further, Nomura will be able to achieve "scale" overnight by getting access to a platform which might have around 30-50 funds already in place with capacity already negotiated (including the terms).

But lets not get carried away here. First, the quality of managers on the platform might actually be second tier. Which quality manager with a queue of investors outside his door would offer up capacity and potentially slimmer terms for the hassle of a managed account? Maybe only the "poorer" brethren. So there are performance questions.

Second, what types of negotiating with regards to fees has gone on between HFR and the manager and might there be in fact some conflict of interest issues?

Third, just because you have "transparency" will not prevent a hedge fund from failing. Look what happened to Lyxor and their investments in well known blow-up Safe Harbor (US$300-400 million MBS fund back in the day). You still have to verify pricing of some of the underlying assets, including all kinds of sophisticated credit-related structures.

Fourth, the managed account format with daily transparency-liquidity might not work well with certain illiquid strategies (bank loans etc). So, maybe you cannot replicate the model over all strategies...

In short, there are are many questions that the platform methodology raises. Certainly, some of these may not be convincing enough to certain institutional investors. I expect that Nomura will find a way to parlay the expected acquistion with an effort to offer "new" products to Japanese retail...they also might consider offering up the platform to other banks/brokers in Asia who simply want to tap into a ready made hedge fund solution with a deep bench of alpha generators across the hedge fund strategy spectrum that will simply be sold with their own distributor private label. Remember too that there already has been quite a lot of private talk of a pominent Japanese money-center bank working closely with one of the biggest hedge fund-asset management firms to create a managed account platform, seeded by the bank of course. So, competition is healthy.
Mahalo!

Friday, July 13, 2007

Allocations Flee Japan Following Poor Returns

"Creation of wealth is almost a duty because of the widespread benefits that flow from it."

John Gunn, Chief executive, British & Commonwealth plc

Follow the Money. Latest numbers extracted from over 100 hedge funds allocating to Asia (including Japan) and based upon HSBC Private Banking and Banque Syz have been eye opening. Plagued by poor performance the last 18 months, many long-short equity managers specializing in Japan have lost assets - either from poor performance as well as from investor redemptions.

First the big picture: Japan lost US$1.6 billion YTD through mid-July 2007; Asia (excluding Japan) gained US$1.3 billion; and, Asia multi-strategy gained US$800 million.

Second, the winners and losers: Highbridge Asia gained over US$450 million, followed by Artradis Baracuda with US$300 million; in Asia diversified equity manager Joho gained over US$400 million; Arnott Opportunities gained US$300 million; MW Tops gained US$300 million; Penta Japan gained US$240 million; and, SR Global gained over US$234 million in assets. Melchoir Japan lost close to US$500 million; Whitney New Japan Investors lost US$400 million; and, Moon Light 04 lost close to US$300 million; Odey Japan lost US$240 million; and, Myojo lost close to US$150 million.

Third, implications: it looks like the big performers of 2005 have been the biggest losers so far in 2007. This clearly raises the question as to whether there are, among other things, size issues related to Japan long/short equity.

Moreover, the latest data would probably also support the fact that emerging Japan long/short managers are going to find it very tough to raise capital and at the very least hit the US$50 million "business sustainability" mark. Not surprisingly, one can expect more outflows and potentially more shut-downs in the Japan long/short equity space. Finally, the clear asset raising advantage of pan-Asia long/short equity plus the growth of Asia multi-strategy is likely to influence the business growth of hedge funds in the region. For example, it might make good business sense to have a more pan-Asian perspective to long/short equity rather than a simple country only perspective.

This is likely to be the case with a number of Japan managers. It might also prove to be one way that they build up operationally in Singapore, Hong Kong or even Hawaii rather than simply in Tokyo. For now at least, Korea, China and India seem to be the big asset gainers while Japan is emerging as the allocation loser.

The foregoing raises important questions regarding the future development of the hedge fund industry in Japan.

Mahalo!

Wednesday, July 11, 2007

China Builds Sovereign Wealth Fund

"It does not require a majority to prevail, but rather an irate, tireless minority keen to set brush fires in people's minds. "

Samuel Adams, 1722-1803, American revolutionary

In a recent Reuters news article, it was reported that a soon-to-be created Chinese investment arm and state organization is in talks with Dubai's Maktoum family's investment agency called Dubai World. They are apparently looking to co-coperate on joint investment opportunities.

Chinese FX coffers are now overflowing with dollar reserves amounting to a record US$1.2 trillion by the end of 1Q07. To placate pressure on their own currency and to deal with the "embarrassment of riches" China is looking to quickly graduate into a global investment powerhouse using this cash war-chest. This is the goal of China's State Foreign Exchange Investment Cooporation.

It follows the surprising news in June 2007 that the same Chinese organization was taking a 10% stake in the U.S. private equity shop Blackstone for a reported US$3 billion. As one of the foremost private equity shops the Chinese will probably learn quite a lot about how to buy into large companies - something that they had previously failed to do, particularly in relation to the most recent purchase attempt of Unicol the U.S. energy conglomorate back in 2005. That certainly set off "national security" overtones to the debate.

It appears that China has looked at some other organizations which are correctly identified as SWFs or "Sovereign Wealth Funds". According to Morgan Stanley these SWFs control close to 2.5% of global financial assets and in 10 years this could rise to 10%. The same type of State run investment model is currently followed in slightly different forms by other countries in the Middle East and Asia fueled by oil cash inflows and/or FX reserves. You can add Russia with its Stabilization Fund to this growing list.

The Chinese model is typified by GIC and Temasek of Singapore which has broad investment powers across traditional and alternative asset classes with the bulk of assets in real estate and private equity. Both manage assets of US$100 billion and US$84 billion respectively. GIC has approximately 20% of its portfolio invested in hedge funds, private equity, real estate and commodities.

Other recent high profile activities by SWFs included: 2007 Delta Two, controlled by Qatari Royal family which bought 25% of U.K food chain Sainsbury; 2006, Dubai Ports World (part of Dubai World) which bought shipping conglomorate P&O group for US$6.8billion; 2006 Temasek (controlled by Singapore government) acquired Shin Corp, the Thai telecommunications group; and 1988 Kuwait Investment Office which purchased a 22% stake in the U.K listed oil group BP.

This is a natural process and could quickly put China near the top of the ranks of investable AUM (together with a few oil-rich Gulf states, GIC and Japan's postal service). It will also inevitably lead to even more liquidity hitting the global markets fuelling even more talk of bubbles, asset price inflation and the like. Perhaps too, it will serve as an early sign that the next highest paid investment bankers will be those catering to the Chinese government in terms of offering preferential deal flow in return for ther recycled-U.S. dollars.

As Asian pride, and in particular Chinese pride and quasi-nationalism takes root you can look for entities like CITIC (a Chinese state-financed hedge fund) to get more support and experience testing newer markets and strategies. Who knows? More ties ups and purchases of "western expertise" might be on the way including hedge fund of fund shops, VC shops and real estate firms.

In the chase for these riches it is no doubt on many hedge fund and hedge fund of fund manager's agenda to consider opening up an office in Shanghai or better yet Beijing. I would not be surprised to hear of office openings in coming months.
Mahalo.