Asian First Quarter Fund Performance: A Mixed Bag

"When angry, count ten before you speak, if angry speak a hundred".

Thomas Jefferson (1743-1826)

3rd President of the United States

According to a recent HSBC Hedgeweekly newsletter, Asia Multi-Strategy category funds were down by a collective -2.86% over the first quarter. Of equal note, were the lower assets of those funds following a trend that turned sharply lower beginning in the summer of 2008. Not a good sign.

Their Equity-Diversified Asia category of funds were also down on an equal-weighted basis in the first quarter to the tune of -1.26%. Again, 15 out of a total 22 funds produced negative returns while overall assets again appeared to "bleed" over this period. These are funds that tend to be long/short equity with a regional Asia focus.

A rosier picture was provided by hedge funds with a focus on Japan. According to the data, the Equity-Diversified Japan category of funds produced an average return over the first quarter of approximately 6.30%. This is news! A total of 8 out of 12 funds produced positive returns. That said, another worrying sign was the noticeable fact that the individual assets of these funds in their survey were by any accounts, small (of the sub-$200 million).

Over the same quarterly period, standout positive performers included: Scott Booth's Eastern Advisors (+19.80%), Bob MacCrae's Arcus Japan (+15.31%) and Lesley Kaye's GAM (+13.33%). All in all, a mixed bag in terms of hedge fund performance in Asia with those funds focusing on Japan the standout winners.

There are a number of subtle interpretations. First, the global number of Asia-specific funds has fallen "off a cliff" since the credit crisis and this might have to do with poor performance. A second theory posits that the biggest investor group in Asia over the last 10 years were hedge fund of funds and as these vehicles have been hammered by poor performance and equally poor liquidity they have pulled investments en masse from the single manager universe. Certainly, the anecdotal evidence supports this theory.

Further, another investor group and seeder of many funds - Japanese institutional investors - has been bailing out of the regions funds and has done so in size. One need only think about the number and scale of Japanese trading companies that have effectively shut down their overseas hedge fund of fund operations over the last 24 months adn this group alone had a combined $4-6 billion in combined, investable assets!

A more hopeful theory suggests that the "old guard" of Asia-based hedge funds have been shunned by investors in favor of a new selection of managers who are not on the HSBC radar screen. This may well be possible. Although, the pain suffered by hedge funds in general in the west suggests that investors have simply been in redemption mode and have shifted among some of the remaining vehicles rather than supporting a fresh selection of up-and-coming managers.

So much for US and European prime brokers proclaiming 6 months ago that the Asia prime brokerage business was heading into a boom - maybe that was hope rather than reality. Expect many of them to slowly start retrenching also as all boats slowly sink in the current environment.

Until local institutional investors come back, the region will be a toxic trading ground. The good news is that any capable manager will probably not be involved in any crowded Asian trades for now - unless they are liquidating with the broader, schizophrenic markets...Mahalo.

Singapore Waits With Open Arms & New Rules

"Yesterday is not ours to recover, but tomorrow is ours to win or to lose."

Lyndon B. Johnson (1908 - 1973), 36th President of the United States

MAS, the central bank of Singapore has recently announced new controls for exempt-fund manager entities with assets over S$250 million ($182 million). Over this benchmark, funds will require to be licensed. Those hedge funds below this will require base capital of S$250,000 or $182,000 presumably held in escrow in a local bank account.

Damage done? Probably not. For many firms with AUM over the $150-185 MM barrier one is looking at the average hedge fund industry single manager assets anyway. The need to license will presumably be more form filling with regards to staffing, activities and presumably some frm of transparency with regards to assessing portfolio risk using whatever metrics MAS thinks are necessary to assess industry wide risk.

The fact of the matter is with the EU and the U.S. poised to introduce more of a hands on approach to the exempt-fund manager industry, including potentially setting pay, one can expect a growing number of disgruntled workers to locate in more favorable regimes and climes. In this regard, Singapore is likely to continue to be attractive.

Over the longer term, aside from taxes and compliance costs, any real sustainable hedge fund industry growth in Asia that invests in Asian assets must require the growth of new products including the development of a viable local fixed income market. Mahalo.

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.

Japanese Investors & Toxic CDOs

"Even sheep should have brains enough not to follow the wolf".

Joseph Goodfield (author)

Even following an apparent letter to investors sent out by GS, you just know that Japanese institutional investors including city banks, regionals, insurers and pension funds bought a ton of CDOs backed by toxic real estate assets in the 2006-2008 window.

CDOs were attractive investments. They promised juicy yields and in many cases a AAA rating or a famous AIG guarantee. Back in 2006 the Accounting Standards Board of Japan made noises about excluding AA and higher rated CDO tranches from mark-to-market accounting. This was underpinned by the then-new Basel II requirements that effectively removed CDOs from being counted as regulatory capital for many banks in Europe and Asia provided they were of a particular rating.

Add to that the fact that the overall decline in credit spreads contributed to buyers moving down the credit curve to pick-up yield and it is easy to see how these products exploded in interest increasing 76% in 2007 to reach Euro 101 billion of rated credit issuance.

Japanese city banks and brokers likely played a key role as distributors or co-distributors of much of the U.S. structured paper, and probably in the later stages, or just before the 2008 collapse of credit markets in general. Much has been made of Mizuho and it's fateful move into the business in 2008. They would have done so using their bond salesforce who would have had little to do selling no-yielding JGBs.

In fact, the 2004-07 period was also a time when intermediaries "sold" many of the big name fund of hedge fund products (some of which no longer exist e.g. Ivy), again for the attraction that many of these products had offering juicy equity-like returns with fixed income-like volatility.

Many institutional investors had a bogey of 8% which was tough to reach in a 4% investment environment. There were strong incentives to buy these derivatives. Moreover, the returns for bank distributors were astronomical, with the riskier tranches of CDOs getting 150 bps in fees against the 30-55 bps that were associated with higher grade structures. So there were clear incentives to move the riskier products too.

The real scale of the Japanese institutional investor appetite for toxic CDOs is very hard for anyone to define, although it might be the case that in the same way that they accounted for about 20-25% of global HFoF sales in 2006-07, they might have also accounted for a similar amount of global CDO business. That means, out of an estimated 4Q2007 global issuance of $47.5 billion, maybe just under $10 billion was bought up by Japanese institutional investors in that period alone.

Of course many of the banks had to suffer the embarrassment of realizing this as losses, while other pension funds simply buried these "mistakes" among their broader portfolio losses. At some time in the future the truth surrounding Japanese investor losses in these structures is sure to come to light. It always does. Mahalo.