Long Short Equity Funds and a Receding Edge

"A thing worth having, is a thing worth cheating for."

W.C. Fields, actor (1880 - 1946)

Back in the 1990s and early noughts, Julian Robertson's Tiger Management represented the benchmark hedge fund trading operation in Asia. The firm was wildly successful racking up impressive returns. It wielded the most capital and was in the good graces of most bulge-bracket prime brokers that in turn offered up access to juicy deal-flow, IPOs and stock-borrow.

In the early days, the firm operated like Soros through on-the-ground intermediaries with a local brokerage presence in order to facilitate their shorting activities. that was often the biggest hurdle to effectively build big positions, to hedge or to take a negative contrarian position in a retail-dominated markets.

Operations were manned by long-term foreigners and a handful of local "advisors" familiar with macro issues, like government and central bank policies and timing. Their networks were deep and typically ran all the way to the top of the financial pyramids in Asia. They were also secretive, except in crisis, when the scale of their positions were exposed. That is what happened at the time of the Asia Crisis in 1998 when allegations of insider information raged as it related to Thailand, Malaysia and Hong Kong.

Another often overlooked aspect of hedge fund success in Asia was the unwritten rule to share information and to execute "gang-tackling trades". This was most evident in Japan in the 2003/04 time slot when a whole host of large multi-strategy hedge funds and a group of smaller ones all executed "similar" trades around the same time in the same stocks to play the rebounding Japan economy theme through bank stocks.

It was also evident in the investor activist fund activity, again in Japan, and often facilitated by local brokerage companies and banks who typically held the key in terms of stock borrow to put pressure on corporate board management to change. Lehman Brothers became a big background player in this area and a number of their former employees went on to leave the firm and set up firm to specialize in this area. And, for a time they did rather well.

Then the environment changed. Financial authorities started to gather information, and started to track the activity of many of these "liquidity providers" as well as to plug many of the privileged information loopholes that generated many of these fantastic returns. But the biggest change came from the economy itself. More entrants and more information leveled the playing field, in Japan, the role of the activist was challenged in the media, in the boardrooms and in the courts. As equities faltered, so the number of IPOs dwindled and with it the go-go returns of many, many long/short equity funds. Their ability to distinguish their unique alpha traits from beta had started to vanish and has continued to do so.

Returns of the top producers have subsided, or become more volatile like typical emerging market stock risk/return profiles. Many have blown-up or effectively gone underground -no longer taking outside investors and operating now in secrecy without the attention of investors or the authorities. Prime broking has also become more expensive, capital intensive and less of an easy-money game.

Investors have changed too. Becoming more institutional, many have stressed consistency of returns rather than volatile out-performers as it tends to be "safer" to their principal investments. But in so doing they have lost their differentiating qualities from other non-Asia based multi-strategy managers.

Investors have also become more aware of capital sizing issues that today's hedge funds can put to work. More than in developed markets, it is very difficult to put up +20% net of fee returns with $500 million in assets under management (without benefiting from outsized sector/stock bets). This is why some managers that have continued to focus on the Tiger "edge" have and will suffer. The financial world is flat and they need to adapt genuine skills that fit this new environment, or else they will close up, go home and return investor funds forever as the passive indices and funds take market share. The tiger in the marketplace may well become extinct as it is becoming in the wild! Mahalo.