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Hedge Funds in Asia

Monday, September 29, 2008

Nomura & Mitsubishi UFJ Buy American

"Recent transgressions in financial markets have underscored the fact that one can hardly overstate the importance of reputation in a market economy..."

Alan Greenspan
Former Federal Reserve Chairman (speech 2004)

After the humiliation close to 10-years ago when the Japan premium forced Japanese banks and brokers to adjust to a new world involving a higher cost of borrowing, the big boys are back! Earlier in September, Nomura agreed to buy Lehman's European and Asian operations after it filed for bankruptcy. How this impacts their prime brokerage business is as yet unknown.

Up to now Nomura has quitely but agressively built up its synthetic prime brokerage business in addtion to its DMA (direct market access) accounts through a previous acquisition of a major electronic platform. Critical will be the ability of the firm to build up its book of accounts especially with global multi-strategy shops based out of London and Hong Kong where Lehman had some market penetration.

On the other hand, major money-center bank, Mitsubishi UFJ agreed to pay a reported US$9 billion to purchase up to 21% stake in Morgan Stanley. This might be a mojor coup given Morgan's preeminence in various league tables servicing hedge funds around the world. However, with capital and leverage now drastically being cut back just how much of Morgan's business Mit-UFJ will be able to sustain remains a big unknown. The business model is broken and no-one knows for sure how the landscape will change. Mahalo.

Thursday, September 18, 2008

Morgan Stanley and Chinese Wealth Fund Talk

"German Engineering, Swiss innovation, American nothing."

Advertising slogan used on a billboard in South Africa by Daimler to promote its smart "forfour" compact car.

Flashback to 1998 (less than 10 years ago). Who would have thought that Asia's ravaged economies would now be in a position to "rescue" some of the developed world's most famous financial institutions? If I told you that a Chinese organization would buy-in and potentially buy-out out a blue-chip U.S. investment bank many would have laughed in my face!

But the F.T. reports that China Investment Corporation,the US$200 billion sovereign wealth fund, which already owns just under 10% of Morgan Stanley is now in discussions with the bank for a further increase in participation. Interestingly, the private equity shop, J.W. Flowers which was famous for the creation and IPO listing of Shinsei Bank in Japan runs a fund with over US$3 billion of CIC money focusing on financial institutions and might be included in some way in talks if a full-fledged takeover were in the cards.

In normal times this kind of activity would almost certainly become a political hot-button. Funny how the media and politicians are now suddenly quiet!

What appears clear is that China, Singapore, Korea and potentially Japan all have currently well-capitalized SWFs and are now becoming more "international" in their ambitions. This can be good, for the survival of developed world assets in the short run but can also lead to other kinds of dependencies down the road. Globalization can flow both ways.

For example, there is now an even bigger reason why any forecast global slowdown cannot be allowed to infect the emerging markets heading into 2009. If as a result, these SWFs are forced to ultimately withdraw their support and financing for the U.S. financial system either directly or indirectly due to harsh domestic conditions at home (including civil unrest) then the current credit crisis might seem like a tea party. Be careful what you wish for!

Onb the bright side, at least the heads of some of these i-banks might at last become truely internationally-focused. They certainly only were in talk in the past. Expect their boards to include foreigners and even the CEOs of U.S. blue-chip investment banks to be ABC (American Born Chinese). Makes sense to me. Move overAnglo-Saxon stereotypes... the global leaders of tomorrows financial institutions are coming from a developing country near you (with money to prop up your bank).

Expect CIC to step up and buy more of any Morgan Stanley offerings. The prescendent is there. The only real issue is probably the price and most certainly this is where the real horse-trading will happen. Mahalo.

Wednesday, September 17, 2008

Lehman Fall From Grace Taints Japan Inc.

"I begin to smell a rat."

M. De Cervantes

The collapse of Lehman Brothers has impacted Japan in many ways. Lehman had for many years been one of the elite I-banks that had thrown off many stock traders and M&A specialists that had gone on to set up hedge fund operations in the region; some of which had had books written about their early career exploits (e.g."Ugly Americans...") while others had been involved in audacious blow-ups.

The bank itself rode the wave of high profile and very profitable investor activist deals before that whole business model slowed down drastically a couple of years ago with the arrest of Murukami of MAC consulting fame.

In recent days, there had been strong rumors that Nomura had been interested in buying out Lehman's U.S. operation. The positives at the time had focused on the opportunity for the premier Japanese shop to flex its global muscle and pick up the recognized jewels of investment banking contacts toegther with a blue-chip investment management operation in Neuberger Berman.

The rest of the Lehman operations pretty much overlapped with Nomura's own global reach in Asia, London and to a limited extent the U.S. So the thought, together with an intense fear of the unknown on the balance sheet meant that Nomura pulled back from any serious discussion. The risk-reward was not attractive.

The Lehman Legacy is now looking ugly (like the famous book). Yesterday, the WSJ reported that a number of Japanese banks were sizeable creditors as Lehman bankrutpcy proceedings took shape in Japan. The extent of the exposure to toxic Lehman Legacy took the equity markets by surprise and banks stocks were punished on the TSE (as they deserve). The TOPIX and Nikkei 225 sank in unison.

It is funny how the banks criticize hedge funds for transparency when they themselves prove to be non-transparent time and time again!

This time around the list of tainted Japanese banks is long. Shinsei Bank and Aozora Bank were large Lehman creditors. Mizuho Financial lowered guidance on 3Q profits by US$113 million due to unrecoverable Lehman loans in the form of a credit-link loan and in senior corporate bonds issued by LB. Lehman itself offered that it owed US$289 million to Mizuho Corporate Bank (a subsidiary). Mizuho later laid this loan off of it's balance sheet, probably to many of Japan's smaller regional banks, with only half of it backed up by collateral.

SMFG, one of the biggest money-center banks admitted to LB loans (and losses) to the tune of US$980 million, with US$880 million secured by collateral. It also held US$500 million in LB corporate bonds.

Mitsubishi UFJ Financial Group, the other money-center behemoth admitted to US$275 million in exposure.

This is where the tire hits the road. As in a lot of recent business in Japan, banks were hungry for "good quality" high yielding names to buff-up their balance sheets. Due to Basel II Regulations many had taken the route of pulling back from exposure to hedge funds over the last couple of years.

In its place it was taking on this paper onto its own balance sheet, selling it on to other institutions in Japan (probably including pension funds who do not care so much about mark to market) but also in structures which may have been sold through the broker networks to retail clients as "safe fixed income investments". The Bank of Japan will probably be looking very carefully into this issue.

In Japan, like in Italy and Germany, many institutional investors hold the coporate bonds of U.S. financial institutions. The latest collapse of these brand names is likely to have very harmful brand damage on the distributors and on the retail masses who ultimately lose out in poorer then anticipated performance.

So while Nomura and others did not step into the LB mess directly, one will probably be hearing in coming months just how disperse the collateral damage will be. Of course, many of Japan's pension funds will not speak too loudly about their performance but all indications suggest that the Lehman collapse and deterioration in financial corporate bond holdings will represent yet another "kick in the portfolio ankles" for Japan's banks, regional banks, agricultural banks, credit institutions and pension funds. Mahalo!

Monday, September 08, 2008

Nippon Life: One Step Forward, Two Steps Back?

"The best way to keep one's word is not to give it."

Napoleon Bonaparte (1769-1821)

Surprise! Surprise! Japan's largest life insurance company has just announced to the media (Bloomberg) that it will boost it's allocations to hedge funds by US$300 Million from a current US$920 Million.

Nippon Life's annoucement is in line with other institutional investors in the U.S. and Europe. Many of these organizations with fixed liabilities heading into the future (pensions/insurance claims) have seen the bulk of their investments suffer the pains of falling equity markets, real estate, credit and most recently commodities. Quite literally this has led to many portfolios only reaching a 0%-5% target range, when they typically have to reach a 7-8% bogey in order to reach their investment goals over a particular time period.

Now we have Nippon Life declaring that distressed assets look sexy! Well, certainly if one had been shorting the asset class like John Paulson over 2007 one would have produced outsized positive returns. For the rest of us, it is worth remembering that distressed investments are typcially long-biased and very dependent on credit spreads in addition to the equity market movements adn liquidity.

As any junior fund-of-hedge-fund (HFoF) analyst would know, over the last 12-months through July 2008, this asset class has produced negative returns e.g. Credit Suisse/Tremont Distressed Securities Index returned minus 4.36%. This makes investing in distressed securities a very tough proprosition to justify to an investment committee especially if it is done through a double-fee paying vehicle like a FoHF.

Certainly an investment in credit and distressed securities might make sense depending on your expectations for the strategy.

Even then, one should be worried. For example, many managers do not expect a material increase in bankruptcies in the third quarter of 2008 even though they do expect credit and macroeconomic fundamentals to deteriorate. As with other credit strategies, the situation in the short term is likely to remain unchanged from the second quarter. This means increasing volatility driven up or down by the broader equity or credit market moves, in addition to the occasional company-specific event.

The other issue that the recent declaration revealed was the apparent absence in investment in directional managers, specifically global macro and managed futures. Ironically, these two produced perhaps the strongest returns over a recent 12-month period of in excess of 14% according to the respective Credit Suisse/Tremont substrategy indices.

Why has Nippon Life avoided these strategies is a relevant question to ask? This makes no sense, unless there are legacy issues surrrounding previous management/NL regimes that invested in such strategies and they "blew up". Once bitten, twice shy.

Finding an appropriate investment strategy takes thought and hopefully not too many mistakes (like investing in Asian funds). What is important is the way those investments are made, which means looking at the cost, as well as the scalability of the vehicles and correlation issues.

It must surely be time for Nippon Life and others to consider buying a HFoF or simply getting into the hedge fund incubation business in order to maximize the enterprise value of those investments and at the same time to gain some access to capacity. But as a few others have already learned,hooking up with the "best" managers is not as easy as it sounds. Either way the clock is ticking on Japanese institutional investors to get their respective programs sorted out sooner rather than later. Mahalo.