hedge fund hotel-hawaii

Hedge Funds in Asia

Friday, March 05, 2010

Nepal Hill Nice But Lower Taxes & Innovative Hedging Instruments Even Nicer

"The solution is to gradually become free of societal rewards and learn how to substitute for them rewards that are under one's own powers. This is not to say that we should abandon every goal endorsed by society ; rather, it means that, in addition to or instead of the goals others use to bribe us with, we develop a set of our own."

Mihaly Csikszentmihalyi, author, The Psychology of Optimal Experience (1990 - )

A co-ordinated publicity campaign to attract hedge funds to Singapore has taken another step forward. While news that a former enclave of currently empty buildings in an area known as Nepal Hill is waiting for new hedge fund tenants, there is no guarantee that it will be successful.

It is interesting to take a closer look at the hedge fund "enclave" at Two Greenwich Plaza which was originally housed by small shippers, manufacturers and lawyers. Back in 2005 this was one of the most desirable locations for single managers, CTAs, hedge fund of fund firms and other service providers such that an estimated $20 billion in assets were controlled from that building.

Greenwich sits close to the Long Island Sound with a number of private beach communities, the Indian Harbor Yacht Club and spacious country homes, in addition to high quality private schools. This, plus the fact that CT state taxes are lower than those in NY made it an attractive option for growing hedge fund managers that was close enough for city meetings but far enough away to escape the pressures and high costs of Manhattan apartment living.

Fast forward to 2009. Almost 80% of commercially-leased space in the Greenwich enclave and its immediate surroundings comes from financial firms with a big, big part of that directly connected to the hedge fund industry. This over-dependence has seen a fallout as the industry has fallen out of bed. Firms have collapsed, shut down and left altogether. Rents have fallen and the resulting office space has been divided up to accommodate a smaller, more diverse tenant profile.

The better bet for Singapore would be to work on improving the corporate and personal income tax regime to enhance not only the hedge fund but also private equity and venture capital environment. At the end of the day, rather than looking to encourage managers to arbitrage between locations and jurisdictions for the short-term "fix" in Asia, the real long term solutions are likely housed in encouraging new fund formation, finding the "Singaporian George Soros" of tomorrow and getting more institutional investors involved in backing emerging managers.

Managers will move to Singapore if they know that big allocators, family offices, endowments, pensions, insurers and the like are there too looking for investment opportunities.

On another not unrelated note, still a lot more can be done to improve the availability and depth of Asian exchanges as well as the types and numbers of derivatives. For example, the development of greater activity in an Asian fixed income market would be a huge step in the right direction as well as greater co-operation with western exchanges like the CME in order to increase the number and depth of instruments that can be traded in Singapore and other locations.

At the end of the day, the long term success of Singapore to develop its status as the Geneva of the East relies on unleashing an entrepreneurial spirit and drive in its manpower. In this regard it has a fight on its hands with Hong Kong. Remember too that Greenwich is also the place where LTCM, Amaranth and many other funds blew up. In fact, one could argue that in this post-credit crisis example there is a movement for new clusters to move out of the large metro centers into cheaper areas where cost of living including rents are now significantly lower. So the takeaway from this is be careful who/what you look up to if you want to avoid similar pitfalls. Mahalo.

Thursday, March 04, 2010

Are Asia-Specific Funds Scalable?

"Glory drags all men along, low as well as high, bound captive at the wheels of her glittering car."

Horace (B.C. 65-8)
Italian poet

Are Asian funds really scalable? By scalable, I mean can they grow to +$10 billion organizations in the same way as a Tudor, Caxton, Millenium, D.E. Shaw, Citadel or Winton? This is the $46,000 question that faces the bulk of managers in the region and the hard reality is: no!

Once the hedge fund is up and running with $100 million or so in assets, the real test moving forward is whether the strategy or strategies are sufficiently "deep" to enable growth of those assets to the $250-400 million barrier. Can the manager still make 1-2% effectively net of fees every month? Is that even realistic? If the answer is "yes" then there is a high probability that the firm will remain a going concern longer than the typical 4-6 year lifespan of the typical hedge fund manager.

However, as the 2008-09 investor experience shows, today there is little appetite for illiquid strategies. This is one of the reasons that many global multi-strategy funds have been pulling back resources from the region, with Citadel in Hong Kong being the most notable recent name.

Whether a manager can build assets up to $250 million is the real issue for many institutional investors. Below that number, there is often little desire or inclination to allocate their typical +$10 million investment slugs. Moreover, now that the hedge fund of fund business model has effectively collapsed, there are few/no allocators on the horizon to bridge this asset gap for the so-called army of new start-up hedge funds that many so-called informed prime brokers say are about to launch in the region. They are amassing like foot soldiers with knives and sticks trying to help institutional investors who seek protection from portfolio destruction in a post-credit crunch world.

Without a consistent supply of investment capital coming from institutional investors - presumably from the west - the long term outlook for the vast majority of single strategy managers looks bleak.

Accept that you will be and should be a low cost boutique operation and you may survive. You may have a couple of quarters or even years when the beta headwinds will be blowing strong behind you so you will grow through investment gains, but this too will attract more speculative inflows rather than long term institutional investors.

Managers need only refer to Exhibit A: Japan in the 2004-06 period.

You cannot rely simply on long/short equity, especially if you do not really ever go net short. Event driven activists grew AUM in this period and then hit the proverbial brick wall of poor publicity, scandal and poor performance, while merger arbitrageurs have never ever taken off due to institutional barriers especially when it comes to foreign interlopers daring to "challenge" local managers who are quick to wave the nationalist flag to protect their interests and voting power.

Macro as a strategy has not really ever taken off in Asia. Many of the best protagonists came out of the the investment banks who had billions in bank capital, access to deal flow and who had a ready-made operational efficiency in place to handle a variety of tasks. On another level too, local Asian markets have never been as liquid and flexible as those in the west in terms of the number of instruments traded as well as in the offering of derivatives or other hedging instruments.

Sparx understood this and has tried to bolt together some of the varying strategies, albeit not in a single product. It started out as a Japan-centric shop and realized in the mid-2000s that this could be an albatross to future P&L generation if the markets did not consistently offer beta, attract investors and ultimately produce returns. This has been tough going. So they replaced one beta market (Japan) with another (China), then added some arbitrage strategies for a better product mix. But even Sparx has found it tough going trying to be the Fidelity of Asia.

Ultimately, Asia is a source of niche strategies with big limitations in terms of scalability so to want to build a $5 billion hedge fund empire based on liquid, alpha-producing strategies may be unreasonable pipe-dream both for the CEO of a growing firm as well as for the biggest institutional investors. Asia is not like the U.S. or Europe, yet. Mahalo.