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Hedge Funds in Asia

Thursday, December 30, 2010

2011 Through the Looking Glass

"Destiny is no matter of chance. It is a matter of choice. It is not a thing to be waited for. It is a thing to be achieved."

William Jennings Bryan (1860-1925)

It is the time of year when speculators pontificate on the hedge fund industry including its winners, losers and overall prospects. Of course many of the comments will prove wide of the mark, but some will be pretty close or may yet be formulated.

See last year's calls made on this blog on December 27, 2009 and I think many would agree that a large number proved fairly accurate.

  • 2011 will be the year of significant change and opportunity in the alternative investment industry. If 2010 was the year of austerity, 2011 will be the year of the global growth rebound. It will mark a time when the US and to a lesser extent, Europe, will join in on the growth story led by the BRICs and developing countries. The good news is that this means plenty of beta opportunities - which may outpace (in performance terms) those ideas "created" in the hedge fund space.
  • Hedge Fund Asset Growth. Overall, the industry appears to have hit a brick wall just around $2 trillion, led mainly by US and European public and corporate pension plans. SWFs are also in the mix. However, growth is likely to slow as beta attracts more assets and investors decide to "go long" some of the underlying assets such as gold or copper via ETFs. Look for broader HF indices to display the fastest growth as hedge funds press their "selling proposition" of high absolute returns to "capital preservation" as the MSCI Emerging Market and MSCI World Index picks up AUM based on strong anticipated performance or between 15%-25%.
  • Managed Accounts will still be the structure of choice for institutional investors keen on investing in hedge funds. From around $600 billion today, managed accounts are likely to account for $750 billion in AUM by end 2011 (+50%).
  • Managed Futures & Commodities. Expect more "spec" money inflows as institutional investors continue to follow passive, low cost ETFs. I expect an increasing number of institutional investors to use copper rather than gold as a component for their investment strategies. Overall, I expect performance in the 20% range in 2011 for the best year in a while. Ironically, as this trend takes place many commodities will start to mirror the performance and correlate more closely with small cap equities like the Russell 3000 Index. In contrast, fixed income arbitrage may not seem like a natural winner in a rising yield environment, but I think it will buck the trend as volumes rise, hedging activity picks up and pressures mount that by mid-2011 more than 50% of the market will believe that a rise in the short term Fed Fund rates will take place by 4Q2011.
  • Geo-Political Risk Factors are likely to Heighten. Oil prices over $100/bl and/or food prices rising an additional 20-30% on tightening supply and demand pictures may make for explosive political dynamics in places such as Africa and Asia where roiting were seen not too long ago on shortages, hoarding and the like. All that is needed is a bad harvest or excessive moisture here or there to dramatically tighten the food SS & DD picture. Farmland and vineyards will continue to be sought after investment assets in 2011 as a voracious appetite from BRIC consumers takes firm root. Asia will be a winner as a net exporter in palm oils and rice out of the Mekong Delta countries.
    • Think Private not Public. It will be important for "alternative investment" performance because truly scalable opportunities will not start out in the public markets in Asia. They will start out in the private arena and overlap with major project finance, private equity, development finance and more generally the race for natural resources and infrastructure. Expect 3-5 fold returns in these investment opportunities but at the expense of liquidity. These types of opportunities favor the larger multi-strategy shops with contacts to source deals and play a role in the capital re-structuring of many Asian corporations.
    • Investors Still Need to Focus on Portfolio Risk Factors. I think that with so many commodity/China investment themes becoming "media-mainstreamed" in 2011 an astute investor will need to take care that managers do not engage in commodity-driven style drift effectively padding returns with junior minor stocks or overseas, illiquid stocks that might not be so liquid in the event of a sharp downturn or credit crisis. Focusing on this kind of detailed risk analysis on a portfolio level, including choice of IPOs will be important to respect the overall risk parameters of the institutional investor. If it is not already a concern among FoHF managers, then it will have to be as it suggests that many performance drivers will be effectively leveraged beta; that is a story that almost always leads to disaster.
    • Japan-based institutional investors will increasingly "go international", opening up offices overseas to access deals and new markets in obscure Asian, African or South American locales. They will be eager to deploy capital to corporate development activity chasing high positive NPV deals including ports, bridges, toll roads and new towns, shopping centers, malls, universities and energy. They will be especially aggressive in this environment as they have already lagged behind the rest of the region in Asia (including the Koreans and Chinese). Look for government financed JVs to led the renewed impetus to make Japanese capital relevant again...
    • Russia has a chance to finally emerge from its credit-crisis induced recession armed with petro-dollars and a long shopping list of development and infrastructure projects to undertake in the run-up to a Winter Olympics and a World Cup in the not too distant future. A lot depends on the ability of the regime to clamp down on institutional corruption and graft though...and that is a big question mark.
    • India Growth Takes Off Again. This will be the real "new" hunting ground for many investment opportunities as large scale consumerism takes root and demand for cars, homes, new towns and white goods spurs the next major demand for industrial materials and construction equipment and power. Likewise, India will continue to search for coal to powers its growth so expect closer ties with Indonesia with some significant deals likely as they open up the country to more mining. As ever, infrastructure remains the main bottleneck for balanced economic growth.
    • Conspicuous Consumption in Asia. Expect more of the Manhattanization of Asian cities. High speed trains linking China to the rest of Asia; across Africa and into Russia will set the scene for more significant global growth. Countries like Laos, Vietnam and Cambodia and the Philippines should see significant inward investment and project financing with agricultural development being a very important part of their overall economic maturity in addition to consumption and travel-themed opportunities as new resort are built for the newly wealthy Asian consumer.
    • The "Death" of Wall Street. I still expect that a broader trend is underway (in line with the direction of US manufacturing and the $) in which the US and London will cease to be the places for major asset raising and listings, as Hong Kong, Shanghai and Singapore IPOs and listings get bigger and more numerous and as their standards for corporate behavior and due diligence are raised. Wall Street will "move east" to foster this change.
    • M&A is likely to be very strong in Asia in 2011. That should be a boon to many hedge funds and private equity players as a whole generation of family-led businesses seek liquidity heading into generational transfer issues. Expect top name deal makers from London to New York to move east to chase these bigger, attractive mega-deals.
    • Family Offices for Asian HNWIs. This is something that has been going on the last 10 years. Oddly enough, many of the so-called "winners" have been large corporate holding company banks - many based in Singapore or Hong Kong. I expect that a smaller number of genuine private banking operations will make inroads into Asia as the super-HNWI look further west to places like Switzerland to manage their assets and handle family trust issues. Finally, the stigma of Madoff may disappear from many of these institutions and the relative attractiveness of a perceived "safe" and strong Swiss franc will again prove to be a major selling point.
    • Performance. I got this wrong in 2010. I expected high returns and in the end most of the industry came in around 7-9% for the calendar year. I expect in 2011 hedge funds to put in higher 10-15% returns as volatility comes back. Smaller funds should be able to post 25-30% returns if they focus on natural resources. These stories may be disappoint many investors using ETFs.
    • The US, FED-induced carry trade is still on, so the good times should continue to roll for now in developing country equities as cheap money form the west heads into "risk" projects and investments in the east (as well as in Brazil). There is no reason why this should change over the next 12-18 months.
    Mahalo!

    Wednesday, December 22, 2010

    Big Fund Launch in the Wings?

    "No matter how rich you become, how famous or powerful, when you die the size of your funeral will still pretty much depend on the weather."

    Michael Pritchard

    GS Asia's trading team that ran the HK in-house principal strategies operation is set to break-away with 30+ employees in tow and a sum believed to be US$1 billion in AUM. This would make it one of the biggest fund launches in quite a while. Investors beware: The road ahead for Azentus Capital is not likely to be all smooth.

    Don't get me wrong - starting out of the gate with a considerable slice of capital is going to help. An expected rally in global equity markets led by the ultra high Asian economies is also going to help too; especially if global growth rate estimates in 2011 hit the 5% as some analysts have recently stated (Jim O'Neil, GS, CNBC 12/22).

    The trick will not to dedicate that money to "developed world" strategies arb-ing Asian stocks vs. US or European ones. The trick will be to build a truly diversified pool of alpha and beta drivers including a variety of duration and liquidity plays. Asia's equity markets are not efficient or deep enough to make money consistently on the short side, especially with retail playing such a dominant role in the greater Chinese markets.

    Taking an approach that mixes in low volatility with high volume strategies including distressed debt, M&A and investor activist situations should ensure a sufficiently diverse mix of strategies. In short, Aventus should plan for portfolio cushions to the inevitable 20-25% slides in the Indian and Chinese stock markets. They are likely to be in a good position to get access to increasing numbers of IPOs that emerge in 2011/2012.

    Additionally, the firm should make moves to draw from a wider audience of regional investors. That means cracking the Japanese pension market, Taiwanese, Korean and Thai insurance companies in addition to making some headway with a number of the regions top SWFs. A tall oder perhaps, but one that should prove more stable than "bank money" which may yet flee back home on the first signs of global financial panic.

    It might also be an interesting idea to consider an early move towards IPO in order to incorporate more capital and a broader investor base yet in the growth plans of the hedge fund. There are already a number of billion dollar funds in Asia; and not all of them have a staff of over 30+, so watching fixed costs will be an important function of the COO at the new entrant...Mahalo!