hedge fund hotel-hawaii

2012-01-10T15:21:00.000-08:00

2011 Asia's Hedge Fund Annus Horribilis

"A man's respect for law and order exists in precise relationship to the size of his paycheck"

Adam Clayton Powell Jr. (1908 - 1972), "Keep the Faith, Baby!", 1967

The debris caused by the risk-on, risk off storm of 2011 uncovered an ugly end to the net of fee performance of many hedge funds, including those specializing in Asia. The HFR hedge fund index came in at -5.25% over 2011 while Asia-focused strategies tracked by HSBC Private Bank were as follows: Asia Multi-Strategy, -3.91%; Equity Diversified Asia -9.06%; Equity Diversified Japan -7.69%; Macro Diversified Asia +6.10%; Market Neutral Discretionary Asia +10.13%; Multi-Strategy Asia -0.15%; and, Multi-Strategy Diversified Asia -15.99%.

Overall, not an impressive performance put up by the industry. That plus rising operational costs and an absence of early western investors suggests that the near term performance landscape will remain bleak with an outflow of AUM and quiet firm closings.

The reasons are numerous for the generally poor showing among the majority of funds. Aside from negative macro money policy actions from a number of the regions cbs, the vast bulk of investors were swept away with the same risk-on and risk-off bipolar like volatility that afflicted developed western markets. In such an environment, much foreign liquidity simply raced back home or sought safety in gold (at least initially) then U.S. Treasuries. More traditional bottom up, stock picking or liquidity driven momentum investing was thrown aside as retail fled for cash or cash equivalents.

Until risk-on returns the picture will remain difficult for long-biased equity hedge fund managers trawling Asian financial public markets. Mahalo.

2011-12-24T07:26:00.000-08:00

Hedge Fund Alpha Gets More Elusive

"The secret of success is sincerity. Once you fake that, you've have got it made."

Jean Giraudoux (1882-1944)

Whatever happened to hedge funds posting 8-12% average returns? Whatever happened to the so called Super Funds producing +200 basis points over their peers and the top quartile of the same Super Funds producing +600 basis points over their peer average? Why all now?

As 2011 comes to a close the average global hedge fund will post anywhere between -5% to -10% (depending upon which database you subscribe too). That is dreadful for a number of reasons.

First, lower performance fees means that GPs, analysts and traders will have less income heading into 2012.

Second, on a broader scale the lower performance means lower commission volumes for service providers such as prime brokers, administrators, auditors and attorneys.

Third, it hurts the returns of the many institutional investors (such as private and public pension plans in the US) that piled into these strategies in the aftermath of 2008.

Forth, the losses undermine the (academic) moral high ground that states that unconstrained, active management out performs relatively and absolutely. This last point is potentially the most damning as it questions many conventional wisdoms about hedge funds, the so-called talent pool that it has attracted, and, the very way that institutional investors approach portfolio allocation today and into next year.

In my opinion, this not a cyclical phenomena but a secular one. The growth of the industry from the late 1990s to today has undergone a number of important shifts. Looking at the distribution of high performing managers and their underlying strategies one can see how the drivers of returns are not static. In fact, they have changed.

In the early days, hedge funds simply made money in equity market neutral trades principally in stocks. They bought cheap stocks and sold baskets of expensive ones. They also rode up the technology-led bubble. This worked for a few short years until everyone fell into the same crowded trades.

Then came the era of "inside information" and access to deal-flow was one of the best features of the return profile of the so-called macro strategies. a number of managers heard about macro changes (interest rates, devaluation policy, forex etc.) before the crowd. They took advantage of these moves and made fortunes.

This coincided with the growth, popularity and outperformance of the so called Super Funds. They also enjoyed a significant cost of capital advantage and access to stock loan, for shorting and event driven purposes.

Then the rules were changed with Sarbanes-Oxley. Instead, the best performers rode the ear of low interest rates and the bull run in bonds in the 2000s in addition to the emergence of emerging markets. It was the time of event driven managers, mega M&A deals and the start of the quant managers and commodities.

The subtle strategy shifts clearly favored the larger hedge funds (Super Funds) that were geographically dispersed and that enjoyed lower cost of capital. They diversified their portfolios and as other did so too they moved into the PE space taking up more illiquid investments to boost returns, as many liquid strategies started to become crowded.

In 2006/07 correlations between managers and strategies started to really move violently. Both short and long horizons reflected a growing correlation between asset classes, and even managers. Now, commodity bets became very aligned with the NASDAQ and equities in general for example. The tipping point became the 2008 Credit & Liquidity Crises. This critical period once and for all eroded the reign of the Super Fund.

The irony is that many of them still managed to survive by shifting their investor base out of HNWI and hedge fund of funds into more institutional "sticky" money such as pension plans. The amounts were larger. The inflows represented investments on previous year's performance numbers -sadly, under different correlation and liquidity regimes. Fast forward to today. Almost all Super Funds are underwater or near to being underwater in 2011.

The onset of Risk-On and Risk-Off crushed previously established correlation patterns. Suddenly, correlations became very high across virtually all asset classes. Moreover, investors were unwilling to take on the illiquid investments that they were in the past. This is the new performance reality. Simply saying that one runs a hedge fund is no longer a recipe to collect high management fees based upon historical returns, certain "career pedigree" or strategy (stock-picking) bucket.

Dreadful average hedge fund returns, and the emergence of high volatility is going to make life considerably harder for alpha producers to fake. The stick is now firmly in the hands of the investors to demand lower fees, or else. Now more than ever, the old DDQ qualifications of a Wharton or Harvard MBA, a stint at GS and "failure" at a Super Fund will not be reason enough for an entrepreneurial manager to hang his shingle as a bone fide hedge fund producing alpha. Ironically, these may be qualifications for eventual failure in the industry.

Let the winners of 2012 be a reversion to an older investment philosophy based on non-correlated returns emerge. Lets also hope that investors come to realize that like the golden goose, finding genuine and consistent alpha in a hedge fund is really hard to come by and that out of the 9,000 or so firms that exist probably less than 100 can actually fit the bill rather than the same 450 Super Funds that have been benefiting from inflows since the mid-2000s. That group sill be culled in 2012. It appears that small may again be beautiful in terms of elusive alpha generation. Mahalo.

2011-12-19T08:30:00.000-08:00

2012 Through the Looking Glass

"Strategic leadership requires one other skill. It requires a readiness to look personally foolish; a readiness to discuss half-baked ideas, since most fully baked ideas start out in that form; a total honesty, a readiness to admit you got it wrong."

Sir John Hoskyns, b. 1927, CEO, The Burton Group

Here is a brief overview of some of the broader themes that are likely to impact the hedge fund industry heading into 2012:

Performance Expectations. Investors need to have clear expectations about what an investment in a hedge fund should produce. It seems that many do not. In fact, they may have unrealistic expectations based upon the fictitious belief that what happened in the past will continue into the future. The truth (in 2011) is that getting +10% may be unrealistic, even for 2012, especially in a zero interest rate environment. 2012 is likely to be punctuated by a continuation of choppy markets and RISK-OFF...much more suitable for trading strategies. In this author's opinion, the investor should be gunning for high absolute returns as well high relative returns i.e. non-correlation to stocks, bonds and hedge fund peers. For many institutional investors this might mean actually reducing their hedge fund allocations in favor of making a greater allocation to a 60-40 portfolio keeping a portion in cash (short term U.S. Treasury Securities) in times of high market volatility. Returns from Asia-based investments are likely to be worse that those derived in a number of developed markets in light of liquidity pressures in 2012.

Macro Themes will Dominate - Macro Funds Not. 2011 has already shown many investors that just because one has a view across a number of different geographies and asset classes it does not mean you will make money. Ironically, it might be more difficult given the heightened cross-market correlations. In fact, this year has probably taught many investors that diversification on a portfolio level might actually increase overall risk rather than the conventional view that it does the opposite. For example, the slow moving train wreck that is European debt, and bank sector difficulties has not as yet made a billion $ for any hedge fund managers (sometimes the goal posts keep on moving). Investors might do best in 2012 by focusing on niche strategies that are not so diversified but rather have quantifiable risks with little counter-party risk factors.

Current Hedge Fund Fee Model is Broken. This authors believes that close to two thirds of managers in 2011 will post negative returns of somewhere between -3% to -10%. Investors cannot and should not pay ANY management fee if there is no performance. In fact, if they do then then there is no real alignment of interests between managers and investors. I expect that a new set of managers will come about that will focus on added-value and the performance fee component. Expect more spin-offs from larger managers and a flurry of commodity related managers to raise assets as investors flock to non-correlated assets and strategies.

Hedge Fund of Funds: A Dying Breed. They are already becoming out-sourced due diligence factories rather than purveyors of an exclusive stable of hard to find managers. They cannot guarantee that they might not provide "stinkers" in their portfolio offerings (Paulson anyone?), plus, they really need to produce at least 8-10% in returns in order to cover their own costs (fees on fees...). One way to survive might be to offer up a real life Darwinian model that on a monthly basis cuts managers who underperform, starting the year with 12 managers and ending it with 4-5 always culling the poorest performers. This seems radical and might only be feasible within a managed account platform but then components of such a platform will have issues in themselves. Overall AUM in the HFoF space are likely to start to decline from 30% in the mid 2000s to around 10% in 2012 as institutional investors realize that performance and fees are not attractive anymore.

Small is Beautiful. Expect hedge fund firms with assets under $2 billion to now represent the sweet performance spot for many investors, as the so called $10 billion+ shops take a bath in 2011. This is a radical change in the investment regime previously undertaken by institutional investors since the 2000s in which the data showed that not only did the larger managers perform better but that diversification of strategies was the sure way to go. Today, that ideology has been thrown out of the window...big managers have not performed well at all since 2008, and moreso in 2010 and now in 2011. Expect an increasing number of larger funds that lose assets and to turn back from being hedge funds to being family offices in order to escape the long arm of regulation and costly transparency and reporting requirements. This is a major change in the way investors view the industry. I do not think that it will necessarily help Asia-focused managers though as many of their strategies are typically not scalable beyond $500 million before diseconomies of returns set in. If they are scalable, they tend to involve diversification (increased risk) and (il)liquidity issues. I believe that a number of larger Asia-focused funds will close if they focus on Asia alone.

Asia Hedge Fund Industry Assets to Shrink 25%. While there are approximately $130 billion in combined AUM today (Eurekahedge), the combination of poor equity markets plus underlying issues related the Asia-region banks is likely to hinder markets. China is likely to be down and India certainly has a lot to do including dealing with high inflation before stocks will take off. As the bulk of Asia hedge funds still focus on long-short equity is is reasonable to estimate that poor performance plus a lack of fund raising will hurt many of these funds. Many will be forced to close like Boyer Allan or RSR capital due to underperformance, while other larger multi-strategy shops will probably cut costs and reduce their exposure to the region especially if global P&Ls remain pressured as they have been. Why retain an expensive office in HK or Singapore with staff when a night desk is relatively cheap Chicago or San Francisco might suffice for now?

Overall, there is likely to be a more focused industry, with many asset gatherers being driven out. A number may simply transform into long-only investment shops too while others might simply split up allowing those PMs with experience with illiquid PE-type investments continuing on their own. Those managers that are able to survive this rough patch will benefit from a whole host of opportunities once the global markets are back on a positive growth course. Mahalo!

2011-12-14T06:09:00.000-08:00

Understanding the Asia Fund Performance De-Coupling Myth

"There are three kinds of lies: lies, damned lies, and statistics".

Benjamin Disraeli (1804-1888), British Prime minister

Asia is not the U.S.

It is not an island with mineral resources, a developed financial market infrastructure, and a powerful domestic consumption motor to keep it going. Never has been and still a long, long way from being in such a situation. But that has not made it attractive with followers highlighting cheap labor, a growing middle class, an entrepreneurial spirit of many of its peoples and the absence of a costly western-style social net for the sick and aged.

Ever since the early 2000's when the world witnessed a rebound in a moribund Japanese economy, and the BOJ effectively offered up a backstop to the domestic banking sector, western investors have been fascinated by the "growth story" of Asia - its products, its export orientation and its ability to offer up global corporations and billionaires. They are in the same situation as the U.S. in the 1920s...private equity will boom and public market gains will soon follow. This was the consensus.

For western investors deep in capital, they sought +20% returns to go afar and in some instances there were many markets and hedge funds that were able to deliver. Buy into Asia after a deep decline and ride it up, or buy "cheap" (levered) beta.

However, since the Great Market Depression since 2008 and rapid whiplash rebound in 2009 Asian markets have failed to pull away from the same impulses that have infected other developed markets.

In fact, many of their equity markets have fallen far further than their developed market partners. Global liquidity has pulled back as "risk-off" has taken hold. Export driven industries have witnessed sales and revenues collapse especially with self-imposed austerity taking grip all over Europe. The outlook is ugly too. Traditional market indices have fallen and Asia-specialist hedge funds have fallen too.

Asian hedge funds have produced ugly returns, often in the -10% performance range through calendar year 2011. Manager belts have tightened, employees laid off and the bulk of strategies have suffered from greater volatility as bank prop desks and capital has been pulled in. This author has said many times that 2011 would be a year of retrenchment in the industry and this will likely continue in 2012 as tough times continue and big money sits on the sidelines of capital markets including hedge funds. Hedge funds have to lived up to all the Asia hype!

The reality is that many Asian large caps generate a greta deal of revenues from export markets that are now in effective "recession". With domestic markets also subject to high interest rates in an effort to dampen inflation, now more than ever Asia is exposed with its growth intertwined with the fate of Europe, the U.S., Latin America and the Middle East. There has been NO decoupling through this cycle, nor should we have expected there to have been given how inter-related industrial product and market cycles have become.

Hedge fund performance of Asia specialists versus global specialists are equally dreadful. There has been no decoupling of performance. None. This year, overall hedge funds have been down around -7% while in Asia the numbers are -7% to -10%. Perhaps part of the problem is that the ability of capital to move more quickly from market to market has effectively arbitraged a lot of opportunities that might have appeared ten years ago, but are simply not liquid enough today. Plus there have been few IPOs to goose returns.

This author believes that in times of stress it is often in the private markets where well-capitalized hedge funds will be able to make a performance difference. Asset market downs are taking place over a number of industries and shrewd hedge funds that understand these pricing dislocations will be able to weather the short-term storm and come out of 2012/2013 cycle with pricing power and valuable assets, especially if they are food, water, energy or raw materials - all necessary for vibrant, growing populations in the region. Asia is not decoupling from the rest of the world. Performance problems are likely to persist. Mahalo!

2011-10-30T08:37:00.000-07:00

The End of Leverage Beta (Hedge Fund) Managers. What Next?

"He who has no taste for order, will be often wrong in his judgement and seldom considerate or conscientious in his actions".

Lavater, (1741-1801) Swiss Theologian and Mystic

2011 is rapidly turning into an annus horribilis for the hedge fund industry. Performance on an absolute and relative basis has been dreadful. Depending on the public database one looks at, roughly 75% of single managers are likely to post negative returns over the calendar year. Those general numbers applied generally can be applied across a number of long-only Asia-focused hedge funds which are likely to post -2% to -10% for the year.

According to Hedge Weekly #43 hedge fund data, by category and on an equal weighted basis, Multi-Strategy Asia was -2.29%; Equity Diversified Asia was -6.50%; Equity Diversified Japan was -6.53%; Market Neutral Discretionary Asia was +9.72%; and, Multi-Strategy Diversified Asia was -15.82% all through the first 3 weeks of October 2011.

Question: What can investors do in light of this? Answer: They need to go back to hedge fund basics.

1. Look for the correlation truth. The fact is that many analysts have spent so much time looking at manager specific risk factors that they have kind of forgotten to consider the strategy or portfolio level risk that has changed since 2008. The heart of this issue is the fact that hedge fund correlation has been changing. The fact is that there are very few single managers whose funds still can claim to exhibit non-correlation to stocks, bonds or even other hedge fund peers.

This is an inconvenient truth, and by implications it means that investors are not in fact investing in "alternatives". Sceptics charge that the vast majority of long-short equity hedge fund managers are simply high-fee, leveraged beta vehicles.

It is incumbent upon prospective hedge fund investors to identify how correlated their prospective hedge fund manager's performance is versus an equity and bond index as well as to examine that correlation over 6-month, 12-month and 36-month time periods. Clearly, the higher the number to 1 the clearer that what they will be looking at is not a hedge fund.

2. Define the hedge. The bulk of long-short equity managers use broad market ETFs to hedge against single stock exposure in their portfolios. This is inadequate. Moreover, the value-growth or large cap-small cap hedge which has often been deployed in Japan simply has not worked. If the hedge cannot be defined then the case for investing in the hedge fund does not exist anymore.

3. Are manager-investor incentives aligned? A.W. Jones offered one of the first hedge fund vehicles in 1949 with a 0% management fee and 20% performance fee. In a climate of awful performance is a sub-par hedge fund still deserved of any management fee? It is easy to see where this question leads...

4. Managed accounts are no guarantee of hedge fund performance. Managers do not like them as they are often lower margin versions of existing fund structures. For investors, having more frequent snap-shots of performance and transparency are no panacea for fraud or incompetence. If the manager cannot or will not provide a comfortable level of information on asking at the fund level then why bother? Forget the middle-man platform provider and simply ask for daily or weekly GAV numbers. The majority of hedge funds do and can provide this information.

The hedge fund industry shake-out which began in 2008 continues and the field is expect to whittle down in coming years. Those who survive will offer products that are closer to the original hedge funds that offered: liquidity, transparency, limited counter-party risk, investment in listed instruments, and, non-correlated absolute returns i.e. genuine alpha managers will get paid, and, the pretenders will not.

With increasing numbers of institutional investors searching for alpha, expect the shortage of good alpha producers to remain one of the most enduring problems facing investors. The end is nigh for leveraged beta managers offering alternative investments. Mahalo.

2011-09-28T05:48:00.000-07:00

Performance Depression Is New Normal For Institutional Investors

"A race horse that can run a mile a few seconds faster is worth twice as much. That little extra proves to be the greatest value."

John D. Hess

The hedge fund industry originally stood for "credible" investment strategies that offered superior absolute performance. They were non-correlated to stocks and bonds; invested in liquid, listed instruments; hedged; and, charged a performance fee and no management fee. These tenets plus early performance returns made them attractive to institutional investors who were eager to escape the sharp swings in volatility and poor performance from long-only investments.

Time change, and the industry boomed. New managers and complex strategies sprung up. Moreover, as stocks and bonds underperformed, the hedge fund industry attracted more assets so they charged higher fees and this attracted even more managers who fled the long-only stock picking world.

But the investment climate changed too. Stocks became more volatile. Bond yields started to sink to multi-decade lows and even the concept of a risk-free asset has been pretty much thrown out of the window in light of banking crises including liquidity and solvency issues.

Which brings us the current predicament facing many institutional investors. Many have moved out of stocks and bonds and have been loading up on hedge funds particularly over the last 10 years. This jives with the anecdotal reports in the media about various public and private pension plans increasing allocations to hedge fund strategies.

According to Infovest21 survey data some US pension plans who used to allocate about 30% of assets to fixed income in 2000, in 2010 now allocate around 18%. This is a staggering decline. It is ironic too as a diverse exposure to long-only fixed income (e.e. Barclays Agg) would have produced a decent return while the bulk of traditional stock benchmarks would have not. Surveyed pension plans also invested 62% of assets in equities in 2000 only to sink to 46% in 2010.

The concept of cash as an asset class has also changed. For many this morphed into a game of chasing yield including products like the PIMCO Total Return Fund. This strategy worked - until it didn't. In fact it produced negative returns as the fund invested in "riskier" assets including foreign currency bonds and high yield paper.

All is not so bad as long as the hedge fund industry can still produce superior absolute returns. That "story" now has started to corrode. According to virtually any hedge fund data source including the Dow Jones Credit Suisse Core Hedge Fund Index, YTD numbers show returns of -6.62% for 2011. For a large institutional investors who typically are targeting around 6-8% in their performance returns this is a stunning fail. And boardrooms are in a panic over the short term as well as the medium term.

The worrying thing is that in the good old days hedge fund underperformance was reserved for small, emerging managers or medium sized shops that sis not have the lower cost of capital or brokerage relationships as the closed big boys. These days being big has become a liability. Virtually all of them have suffered staggering losses that will inevitably trigger a fresh round of investor redemptions heading into 1Q2012. Notice letters will be posted and many will flee to cash. Not even so-called managed accounts will avert redemption frustration at the coming negative numbers.

Which brings us the the real medium term dilemma. Where are all the funds that are non-correlated, charge only a performance fee, are hedged and that invest only in liquid, listed instruments and that focus on positive absolute returns?

It seems to me that there these are few and far between and that the real issue for institutional investors is in creating supply of managers to satisfy their demand. This may mean investing in emerging managers and not with the behemoths that are now too correlated to avoid stepping into drowning market situations such as the recent commodity blow-off. Sometimes the concept of diversification can get you in trouble, especially when the concept of risk can change so dramatically from one time period to the next and from one QE policy thrust to the next. Mahalo.

2011-07-27T08:33:00.000-07:00

2011: Hard Times

"Misery is when you heard on the radio that the neighborhood you live in is a slum but you always thought it was home."

Langston Hughes, Black Misery, 1969

For a majority of hedge funds, 2011 net of fee performance numbers do not make inspiring viewing. According to the mid-July HSBC Hedge Weekly #29 edition there are no Asian-focused hedge funds in their top twenty YTD tables (top: JAT Capital Offshore Fund Ltd., up +29.64%).

However, there were a couple of Asian names in the top twenty worst performers: Bennelong Asia Pacific Multi-Strategy Equity Fund Ltd., and, Blue Sky Japan Ltd - Class A which were down -13.54% and -9.92% respectively.

The picture is equally depressing when looking at equal-weighted performance by strategy. For example: Equity-Diversified Asia is +1.05% YTD (led by PinPoint China Fund Class A USD +11.48%) in which 9 out of 16 managers scraped a positive YTD so far; Equity-Japan is -1.17% YTD (led by AlphaGen Hokuto +1.71%) but in which 4 out of 8 funds are producing negative returns YTD; Diversified Asia represented by only 2 funds is +1.58% led by Brevan Howard Asia Fund Ltd. +3.15%); Discretionary-Japan is up +5.30% led by DB Equilibria Japan Fund Ltd. which posted +6.94%.

Of note, those diversified strategies that purported to be better able to spread risk and capture some of the global themes, mis-pricings and arbitrages appear to have suffered a lot worse than anticipated. In many instances there have to be at least some beta-drivers at work long enough in order to generate decent returns. This does not appear to have been the case as risk-on and risk-off themes have been more volatile than anticipated.

In addition, the China story has quietened down somewhat in the face of monetary discipline; there has been heightened geopolitical risk in various regions to cool investments in general; Japan's tsunami/nuclear issue depressed regional growth and stocks a little longer then expected; US debt default risk has also forced many larger institutional investors to take a sit and wait in non-US assets; while Asian commodity plays via mining stocks have lagged spot gold and metal prices over the last 6 months; and, IPO activity has been quiet too.

With a majority of Asian hedge funds failing to even make up the global hedge fund average of +1.65% on a YTD basis (DJ CS Hedge Broad Hedge Fund Index, through June 2011) the reality is that short term capital allocations are likely to remain very scant when applied to Asia in the short term.

Certainly, the high net worth segment including HFoFs will likely not make any allocations heading into the end of 2011 stretch leaving the bulk of new monies coming from institutional investors - and these will almost certainly go to the multi-billion dollar managers trawling global markets and producing 5-8% promised annual returns, except that even this year those numbers might be difficult to achieve. Hard times. Mahalo.

2011-04-25T07:53:00.000-07:00

Chinese Ponder Focused Sovereign Wealth Funds

"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, author

What do you do when your ostensibly U.S. $ denominated $3.05 Trillion FOREX reserves keep growing, and at the same time as the purchasing power keeps on falling? This is the dilemma facing the Chinese.

Asset allocation is only one side of the problem. Yes, one answer is to establish other SWF vehicles to invest in profitable asset classes not susceptible to this falling purchasing power effect - invest in hard assets and energy. But that still does not explain away another more fundamental issue - the fact that virtually every other asset class is still quoted in U.S. $ terms whether it is oil, gas, gold, or copper.

The fact that more institutions like CIC (=Chinese Investment Co.) will likely be established, a more fundamental issue for Asian investors going forward will be to agree to some sort of currency basket with which to price these global assets. This is the real issue which takes time and political will to make it happen. And for it to really work it requires a substantial re-working of the current Chinese FOREX policy.

Expect behind the scenes diversification by Chinese to keep a substantial institutional buyer in the market to prop up a wide range of commodities including base metals and precious metals for the forseeable future. Demand will continue to outstrip demand imbalance as the commodity and energy bull run continues apace.

If correct, this thesis suggests that other smaller private investment vehicles should also invest in commodities (directly or indirectly) and that there should be a push by the region's exchanges to provide more hedging and liquidity across major commodity futures vehicles. This appears to be a secular shift taking place rather than solely a cyclical one that has naysayers calling for a "commodity crash". Interesting times ahead as hedge funds plus Chinese stay long and rest of the whole gets caught in a short squeeze as the much anticipated collapse fails to materialize. Mahalo.

2011-03-16T16:22:00.000-07:00

Yen Carry Trade End Likely to Hit Hedge Funds Hard

"Men are not prisoners of fate, but only prisoners of their own minds."

Franklin D. Roosevelt (1882-1945) U.S. President

The Yen currency rate is on the move and taking no prisoners. The script is the same. Previous crises, like the 1987 stock market crash, the 1998 Asian Crisis then in Sep 2008 following the Lehman collapse and onset of the 2008-2009 Credit Crisis all led to the yen marching higher.

Fundamentally, risk-averse Japanese investors repatriated vast portfolio assets back to Tokyo from overseas accounts, often with a bit of a lag. This included big institutions such as insurance companies and pensions. But it also extends to retail investors too.

The sheer size of the moves taking the yen to new highs across a whole host of cross rates is unprecedented and is likely to have steamrolled a number of hedge funds and other investors that have played the carry trade (short yen) for months (and years) utilizing low cost borrowed fund to leverage the trade. Many now face the stark reality of imminent margin calls and the forced selling of other liquid assets to raise cash. So much for all those that interpreted recent tragic events as a yen "selling opportunity".

Japanese retail investors in their search for global yield are or were an important component in the global carry trade. This involved borrowing funds in a low interest rate currency to purchase an asset in a higher yielding currency. Over the last 10 or so years Japanese "orphans and widows" piled into Aussie, South African and Brazilian bond funds. These were eagerly pushed by domestic brokers, banks and insurance companies eager to drum up business against formidable postal deposits and in spite of miniscule interest rates afforded by domestic JGBs (Japanese Government Bonds).

Once the natural and man-made catastrophes hit a flight to safety was triggered. Many accounts sold off.

Aside from bonds, Japanese institutional investors were big buyers of structured products; big buyers of sub-prime CDOs, European equities, U.S. municipal paper and USTS. Again, once disaster struck they sold.

Additionally, local banks in Japan are known to hold about $1 trillion worth of Japanese equities on their books. For many of them the all important "uncle point" or breakeven for them on the TOPIX Index is at 800. This may explain why the BOJ is believed to have bought aggressively various Japan equity-related ETFs once the index slumped to around 725 on March 15. The BOJ is now expected to have spent $2.6 trillion in price support activities in stocks and bonds to lift markets and reverse the negative price spirals. But even they might be running out of fire-power.

Anecdotal evidence suggests that some of the biggest hedge funds (based in Greenwich, CT and Chicago) have been the biggest players in the Japan yen trade. Expect possible big losses to be reported in the March end performance numbers, in much the same way that there were divergent performance numbers during the previously mentioned crises. Brave players will already have pulled out and will be playing a yen-trend buying game short-term. Mahalo.

2011-03-12T07:37:00.000-08:00

Tough Times

"Old age is not so bad when you consider the alternatives".

Maurice Chevalier, (1888-1972)

Price and liquidity dislocations are almost certain in the aftermath of the devastating Sendai Earthquake and Tsunami. Illiquidity in certain securities, a rush for cash from local institutional investors (including insurers and pension funds) and a wider dispersion of near-term performance returns now face hedge funds trading Japanese financial and commodity markets.

In the wake of generally poor performance over the last few years the chances are, this will be lead to even poorer numbers and possibly overseas investor redemptions, until the situation becomes clearer.

Liquidity will be a primary consideration along with damage assessment and control for a number of corporations. The initial fallout saw the yen move higher on short-term repatriation of funds as corporate Treasury departments dumped liquid investments (often $ related) and transferred fund back to Tokyo or Osaka parent company accounts, in a button-down the hatches approach. Ironically the yen rate rallied, although this is likely to be short-lived as a longer term decline seems more than possible in the months ahead. This could be a massive move and one of the major macro plays of 2011/12.

An emergency meeting of the BOJ policy members is heavily favored to sanction massive relief monies to repair the damage done to Sendai and surrounding areas; to enact more quantitative easing; and, to possibly set up additional provisions to ensure that Japan Inc. can access cheap funds at this time of need and turmoil. The latter is likely to be in the order of $24 billion to $37 billion in funds according to the BoJ.

Increases in government spending will continue to strain already stretched fiscal balances and likely lead to greater suspicion that sovereign debt will again be downgraded. Again this should have implications on the yen currency rate.

On the news of the national disaster a number of larger industrial companies closed operations in the norther prefectures to ease potential strains on the nation's electrical grid as reported damage impacted nuclear facilities.

Today, nuclear power accounts for 30% of the nation's power needs so that the reality exists for power outages across the national grid. It will take time for many of these larger industrial companies like Toyota and Honda to get back to full production as damage assessment takes place, especially with quake aftershocks now underway.

A more sinister eventuality may involve fear that one of the 6 reactors in the area begin to melt down. This may provoke panic and could actually lead to mass emigration should a disaster scenario start to unfold. There is likely to be movement out of Tokyo to other more southern cities in the short run as the population tries to flee. Expect too the airport infrastructure too, to be overwhelmed as people try to leave the country.

On a consumer level, there are already reports of hoarding of staples. Consumer sentiment will certainly falter dragging down purchases of consumer durables and luxury items. Most Japanese do not typically store much food given the small living space and a preference to buy perishables on a daily basis. Short-term, expect local convenience store shelves will empty out of canned goods, rice cup noodle, bottled water etc.

Longer term logistical issues should solve these problems as long as the banking system is functioning freely and there are no bank runs. In the countryside, this remains a real possibility especially if the earthquake aftershocks continue throughout the country.

While many hedge funds will argue that now more than ever there will be winners and losers in assessing investment opportunities, the net effect will be to initially dent GDP in the current and near quarter. Looking ahead, one has to ask the question whether that northern part of the country will ever recovery not only in terms of economic growth but in terms of being able to re-populate.

My guess is that like in the wake of the Katrina Hurricane in New Orleans many younger people will simply leave the area and possibly the country too. Again, the parlous state of Japanese demographics will come to the fore. How will be willing to pay ever increasing taxes to fund reconstruction and the revitalization of the country? Certainly, no "old" Japanese politicians will be brave enough to face that issue today. They have not been in the past. It would be political suicide to do so. Mahalo.

2011-01-25T09:29:00.000-08:00

Asia Hedge Funds: A Dying Breed

"Men occasionally stumble over the truth, but most of them pick themselves up and hurry off as if nothing ever happened."

Sir Winston Churchill, Prime Minister (1874-1965)

It is indeed an inconvenient truth. Recent news that the grand old daddy of Asia-based multi-strategy hedge fund managers in Artradis is closing cannot be a shock. That the same fate has also gripped Sumitomo Trust & Finance with their Tactical Equity Concepts suggests that more of the same is coming.

The fall of Artradis is not a Japan-specific phenomenon. The fact that the firm once wielded upwards of $4 billion in AUM meant that it found some appeal to institutional investors seeking modest returns (6-8% net of fees) but with very low volatility, and chance of loss. When markets were rational this was a sound strategy. Then when 2008/09 hit and losses ensued, the story became less appealing - what had been touted as a low risk vehicle suddenly suffered steep losses and a flood of redemptions in not-so-liquid markets. Performance was damaged and reputations too. Many FoHF investors, HNWI and private banks simply disappeared as investors in the region's hedge fund industry and Artradis suffered.

After spending many years building up an institutional-quality firm, once the AUM start to leave the front door the troubles inevitably begin: cost cutting, monthly then annual performance is even more scrutinized, fees are negotiated lower to retain existing investors etc. A vicious cycle begins, and ends with certain strategies being cut altogether in order to lower fixed costs as well as decisions about pumping even more principal cash into the venture - but for how long?

Finally, the decision to return AUM and an orderly shut-down. Game over.

The era of the "boutique" hedge fund manager in Asia is fast coming to a close. First off, it really is not that easy to produce 12-15% returns each year in the public markets - not without risking initial capital that is...

Second, the cost of capital for many managers has increased since the crisis. That means that it has started to become more expensive to operate, especially if one is in a high rent area like Singapore or Hong Kong.

Third, with most strategies in Asia taking a long-short route it is not surprising that when those traditional, long-only indices suffer the performance ability of the underlying hedge funds also suffer.

Four, few of the regions banks, or institutional investors currently have an appetite for seeding or taking a private equity type approach to supporting a boutique hedge fund operation (Orix notwithstanding). Perhaps the right kind of deal simply has not yet come along...

Fifth, the end investors themselves have run to the hills, chasing commodities, small cap stocks in certain countries and even into bank deposits which are starting to offer higher returns now that the region's central banks have started to tighten monetary policy in light of an increasing inflation threat.

On the bright side, the way is clearing now for more of the larger US and European trading shops to gain "market share" in terms of access to deals, flow, stock borrow and the like as the remaining primes start to suffer intense competition to justify their own steep overheads in the region. Expect a few of them with bloated staffs to quietly release employees and pull back from prime brokerage as the business simply starts to dry up. 2011 will be an even tougher one for the industry, in particular if one is focused heavily on Japan. The approximately $15 billion in AUM may easily fall to $8 billion by year end. I hope I am wrong. Mahalo.

2010-12-30T09:57:00.000-08:00

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!

2010-12-22T08:26:00.000-08:00

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!

2010-10-24T16:27:00.000-07:00

Orix Hedge Fund Strategy - Ambitious or Misplaced?

"If little dreaming is dangerous, the cure for it is not to dream less but to dream more, to dream all the time."

Marcel Proust, (1871-1922)

Interestingly, it takes a Japanese leasing company to voice an ambitious hedge fund strategy, transforming its role as a distributor of a U.S. hedge fund into one of owner and emerging manager promoter.

Orix is no stranger to the hedge fund business as it has proudly boasted as being one of the earliest Japanese institutional investors in some of the biggest and oldest firms like Tudor, back in the mid-1990s. Their interest was a means to secure absolute returns from proprietary funds at a time when Japanese fixed income rates already low and falling while long-only equity investments were volatile.

Next, Orix got into the seeding business - choosing to focus on Japan and Asian strategy managers. Nice. That turned out to be a miserable failure. It seems that someone forgot to understand the power of correlation in a relatively concentrated portfolio. The company retrenched, co-investors fled and senior experienced managers were reassigned next window seats! This was sad. It marked a lost opportunity.

Orix decided to lean on an existing U.S. relationship with Mariner. This is a firm that has single strategies, fund of hedge fund strategies and a seeding vehicle for emerging managers and strategies. The typical profile of Mariner stresses low volatility and steady returns (except for 2008) that many think could be a useful and critical component for the investment world in Japan.

Orix wants to double AUM from $10 billion to $20 billion in 5 years. This implies a +20%

growth rate each year. There are very few firms with a strict alternative investment focus that have achieved this since 2007. The only types of firms that have managed very high growth rates have had low starting AUM, a solidly compelling strategy/niche, long-only strategies which are low cost or some special distribution prowess.

In my opinion, Mariner is not the firm that fulfills any of these goals. Performance has not been outstanding/notable, there are no compelling strategies (such as private equity or real estate or emerging markets), no long-only products (a feature of AQR) and certainly no distribution expertise, for example, into Japan's pension find market. For these reasons, I expect the relationship between Mariner and Orix to become strained as the existing product line does not solve existing problems.

Orix should focus on sorting out its real dilemma. That is establishing a stronger and deeper distribution platform into the Japanese market. To do so, they might be best suited to strike a deal with an asset management company, agricultural cooperative, a city bank or somehow with a pension consultant. Existing relationships will not do the trick.

Japanese institutional investors are seen as net sellers of hedge fund produce due to costs, poor performance in 2008/09, poor transparency and the imposition of gates (lack of liquidity). Orix would be best served developing a scalable money market fund that is liquid, performs better than regular money markets, and that does not have currency risk. They should also focus on infrastructure and real estate projects in Asia, as well as creating a vehicle to invest in natural resources such as through a private equity fund where the returns would be significantly higher than with a FoHF.

All of the above would assume that Orix senior management understand the real needs of Japanese institutional investors, the lack of value in a HFoF business as well as how they need to "fix" their investment management business.

Ultimately, they need to have a separate organization - perhaps via an IPO rewarding management along western lines and not as "glorified salarymen". If they are not quick to see these issues this will be yet another failed attempt by Orix to build a business, that they will fold and collapse away in 4 years. Ambition misplaced? It sure looks like that. Mahalo.

2010-10-15T08:03:00.000-07:00

Japan-only Hedge Funds Slip into Growing Irrelevance in Asia

"A man is rich in proportion to the number of things he can afford to let alone."

Henry David Thoreau, (1817-1862), author, poet and abolitionist

The data keeps pointing to a very uncomfortable truth; one that has been in the making for a number of years. Stock market capitalization of countries in Asia are increasing in US$ terms almost everywhere - except in Japan.

As equity business tends to form the bulk of trading activity across the region's exchanges this has a big impact on hedge fund location, capital allocations, prime brokerage resources, income disparity across various exchanges and the use of direct market access technology for executing buy and sell transactions.

In the good old days, Japanese stocks were heavily traded, and their brokers were high on global league tables in terms of analyst coverage, investment banking business, IPO volume and equity traded. The rest of Asia was the rump with Korea struggling to break out. Hedge fund activity was rampant in the region especially when Japan was awash with liquidity, a stock market that went-wild in the 1980s only to stumble somewhat in the 1990s as deflation and a bank crisis hit the markets and market sentiment.

2003/04 marked a temporary reprieve as global hedge funds bought ahead of a government backstop behind the big banks. This, plus the promise to keep rates low, allowed investors to buy the banks without peril. Japan Inc. recovered and hedge fund AUM exploded together with their influence on the local exchanges and their activity at conferences, such as the GS Tokyo Hedge Fund Conference. Hedge funds dominated Japanese equity markets, and accounted for as much as 30-33% of Tokyo SE market capitalization.

Those days are no more. More hedge funds have closed than opened in Japan, however hard US and European prime brokers try to announce otherwise -- almost every other month!

The trend of equity market capitalization is a partial reflection of hedge fund activity in the region. Comparing 2006 to end of 2009 data, the value of Japanese stock market capitalization has fallen 28%. Over $1 trillion has disappeared. It is gone- probably to other markets in the region that offer more growth, greater liquidity, IPOs and generally more positive prospects.

And it is not only a case of FX translation too. Japan market cap now accounts for just under 23% of total Asia market capitalization which runs at around $14.4 trillion. Back in 2006, Japan market capitalization represented 40% of Asia market capitalization.

Just as Japan has slumped, Chinese equity markets are enjoying a period of incredible growth. The combination of Shanghai, Szechen and HK stock market cap growth now exceeds that of Japan by over $2.5 trillion. China now represents 41% of total Asia market capitalization.

With year on year growth also picking up in Asia ex. Japan big opportunities are now opening up to grow more hedge fund business out of Singapore, Hong Kong and a new batch of low cost centers with solid infrastructure as affordable commercial real estate is likely to be a negative factor for many firms in the coming years.

Indian stock market capitalization from 2006 to end 2009 has grown by 38%. Like other countries, a net phase in market development will be the extension of company coverage to include more mid- and small-cap stocks and the proliferation of indices that allow for passive (low cost) exposure by the region's institutional investors including banks, insurers, and SWFs.

Sadly, the prospects for Japan look bleak. Investors should be aware that the pan-Asian hedge fund strategies are more likely to produce positive alpha in this next investment phase. The days of a Japan-only strategy are pretty much heading the same way as their zombie economy. Long live a pan-Asia, multi-strategy hedge fund approach.

On a not totally unrelated note: in the same way that a few forward thinking Japanese companies encouraged the promotion of westerners to senior management and board level positions in the mid 2000s, they might want to now do the same to include more Asians at critical board-level decisions if they are going to be able to appreciate the medium-term changes going on in the region's markets. Japan has to get out of depending on capital to come to Tokyo, and instead allow capital to move out to where there are positive NPV projects in the rest of Asia.

It may be time to learn Mandarin, Thai, Tagalog and many of the other regional languages and cultures as corporate development including M&A activity almost certainly intensifies. Mahalo!

2010-10-05T07:58:00.000-07:00

Wider Dispersion of Returns Points to Patchy Hedge Fund Performance in Asia

"If winning isn't everything, why do they keep score?"

Vince Lombardi, (1913-1970), football coach

According to recent hedge fund data (HSBC's Hedge Weekly #40) Asia's hedge fund performance continues to be patchy heading into the tail end of the third quarter and approaching the fourth. In fact, almost all categories continue to lag global multi-strategy managers that posted +6.75% on a YTD basis.

Asia's largest category of funds - those trawling pan-Asian equity markets - consist in the database of 18 funds (not firms) with AUM totaling $9 billion and YTD performance (on an equal-weighted basis) of -1.96%. The biggest gainer is Bob Karr's Joho Fund up 11.90% while the biggest loser was Everest Capital Asia with -12.26%.

In the small equity diversified Japan category with AUM of $1.238 billion for 7 funds, average performance was -0.24% with the largest gainer the Martin Currie ARF Japan Fund at +6.33%, with the largest loser SR Global Fund H - Japan with -12.82%.

Multi-strategy Asia specific funds also suffered a wide dispersion of returns but with overall performance -7.11%. This runs contrary to the performance of their global counterparts. It also runs contrary to the notion that they would be running more hedged arbitrage strategies, unless of course, they were more directionally positioned than previously thought. The largest gainer was LIM Asia with +2.92% while the largest loser was Artradis Barracuda Fund with -18.21%.

As we have already explained, investors looking at Asia should be particularly comfortable with NASDAQ type of return/volatility in a portfolio, and if you are not making the 15-20% returns then you would be better served taking a passive investment in a cheaper ETF that focuses on the beta. The other option is to focus on Asian fixed income and other private equity type deals even though the payback is likely to be longer, albeit with a high attractive IRR. Mahalo.

2010-10-05T06:47:00.000-07:00

Fortress $41 Billion War Chest Coming to Asia

"Imagination is the one weapon in the war against reality."

Jules de Gaultier (1858-1942), French philosopher & essayist.

The announcement that a fully staffed operation will be established in Singapore in 2011 from one of the world's biggest alternative asset management firms, Fortress, fortifies a global trend to focus on emerging economies and regions. The fact that this is taking place from Singapore is also noteworthy as the destination of choice for global multi-strategy players.

Fortress will likely hold around 15% of AUM or $6.2 billion in firm assets in Asia over the next few years. This is likely to be an increase of $4 billion over current estimated levels. One way will be to increase the number of arbitrage opportunities generally in equities, currencies and growing local fixed income markets.

Like Och Ziff, expect an Asian-focused fund to be split off/created in the not too distant future. A second, broader strategy will be to launch a number of private investment vehicles focusing on private equity deals, infrastructure and even mining deals - all projects with positive NPV valuations taking IRR to +30% levels which may not be achievable in public markets.

Fortress expansion plans are a subtle reminder that the near-term opportunities in developed markets are likely to be subdued (i.e. low growth). A further reason for the move overseas will be to better establish local relationships with Asia's growing SWFs including CIC in China as well as with GIC in Singapore - helping those institutions with the execution of their own global investment strategies. It is also a play to get involved in the some of the biggest IPOs that are expected to take place out of Hong Kong as an increasing number of corporate names focus on growing their geographical footprint in the region.

Finally, Fortress may also be preparing to move corporate assets into a jurisdiction that might be deemed "friendly" given the continued pent-up antagonism by the US and European authorities (legal and taxation) against hedge funds in general. Overall, a sound move and one that is expected to be followed by other large US hedge fund players in coming months. Mahalo.

2010-09-01T06:43:00.000-07:00

CIC: China's Real First Hedge Fund

"We shall not cease from exploration. And the end of all our exploring will be to arrive where we started and to know the place for the first time."

T.S. Eliot (1888-1965) Little Gidding

In an investment strategy sense, China's sovereign wealth fund (CIC) is the country's first genuine hedge fund. Established in 2007 with approximately $332 billion in assets under management and fed by swollen currency reserves of $2.5 billion, the operation is currently invested in private equity-type deals cross telecommunications, energy and defense industries. Of course, as we are talking about state resources their considerable size is always regarded as potentially political and suspicious.

As roughly 66% of its holdings are in U.S. Treasury bond and mortgage security assets, it is not surprising that one focus of it's investments has been on U.S. companies including Blackstone, Morgan Stanley (although some say that they were rebuffed when they wanted to invest in Goldman) and VISA among others.

It invests directly, but it also is a manager of managers in the sense that it farms out money to hedge funds and private equity funds that themselves invest in underlying strategies and firms. This may explain how and why the largest HFoFs have been getting bigger in the last few years in spite of the fact that quite a few of them have had fairly average performance numbers since 2008.

As previously stated, expect that the recent investment policy focus into "real assets" to see more of a focus on agricultural products, land and mining operations. It would seem that in situations where significant development and project capital is needed (i.e. deep pockets with a 5-7 year horizon) CIC would appear to be in a good situation. As ever, the political implications in potentially sensitive areas may work to counteract the clearly obvious positive NPV attributes that many of these projects is having on a daily basis.

In light of the above, news today that the first registered hedge fund will be opening up to service local Chinese HNWIs in mainland China should be taken with a pinch of salt.

Remember that in Japan in the 1980s when the stock markets were climbing ever higher, the role of corporations investing in hedge funds and other schemes initially added significant revenues to their bottom lines, until these zaitech departments fell foul when markets turned. Expect similar potential stories to emanate out of China in the coming years. Mahalo.

2010-08-30T07:52:00.000-07:00

China Exposure Yes; Public Markets No.

"I choose the likely man in preference to the rich man; I want a man without money rather than money without a man."

Themistocles, 527 BC - 460 BC, from Plutarch, Lives

Interestingly, many investors continue to ignore the data and facts when investing in China. Like in any emerging market one is often best served in buying the MSCI Emerging Market Index rather than adopting a single country focus. For equities, it is often the case that the long/short equity emerging market manager (with a single country focus) has a very high correlation to the MSCI EM Index but at a significantly higher cost and more risk (as it is by definition not as diversified).

So what should the discerning global investor be looking at when emphasizing exposure to China? First, this is often best done through a fund that has a combination of access to "hot" issues (IPOs), illiquid PIPEs and other illiquid deals. This is typically where real wealth is created in nascent economies and where the value is originated. Of course there are issues such as transparency, independent inventory valuations, and the dubious rule of law when there are disputes.

A second way to get exposure to China is through the private equity/venture capital route often via the U.S. There a number of companies that are situated in the U.S. that focus on the China opportunity and that offer exposure to that part of the world. In recent months the big names such as Blackstone have moved in too.

Third, one can focus on those countries and industries that derive a good portion of business from China. This means Singapore across a number of sectors as well as Indonesia via their mining product exposures that are often exported to energy-hungry Chinese industries. These are often the cheaper ways to benefit from the China Story without buying into the risk and volatility of their local stock markets.

It should come as no surprise that investors need to incorporate China into their portfolios in an explicit way. As ever, the real decision making process needs to understand fully the risk/return profile. The informed investor could be best served by using cost-effective, passive beta vehicles (like ETFs) rather than investing in a hedge fund that doesn't really hedge at all. Mahalo.

2010-08-24T14:19:00.000-07:00

Endaka & Nikkei Put Options Obvious Macro Plays in Japan

"Promises that you make to yourself are often like the Japanese plum tree - they bear no fruit."

Francis Marion (1732-1795)

Japan Inc. is back in play. But not in the 2003 recovery story kind of way. This time, it is the story of paparazzi waiting outside the emergency ward at a hospital with their scythes (and not cameras) sharpened up, ready for another blow to the body of a weakened economy.

The bulk of the paparazzi is comprised mainly of foreigners (security companies, insurance companies, asset managers and hedge funds). As TSE/Osaka stock market volumes continue their multi-year long declines retail investors have joined their domestic institutional counterparts turning their backs on Japanese stocks, especially FX-sensitive exporters.

Curiously, the % of trading value of stocks traded on Tokyo, Osaka and Nagoya markets by foreigners has increased to over 50%. Looking at TOPIX alone, the foreigner component is holding steady around 50-55% since 2008 (data: DIR Investor Guide, July 2010).

The macro trades du jour consists of buying the yen against all currency pairs and buying put options on the Nikkei and TOPIX stock indices. The trades are largely directional and foretell a particularly negative view on a country that used to lead global production of high value autos, consumer durables and was the envy of the world for high growth and high tech.

Korea and China Inc. have taken up the technological challenge and in many cases beaten their Japanese competitors to market with products for western consumers. Sony is now an after-thought for the bulk of post-recession, over-leveraged global consumers.

Expect bank and real estate equities to be picked apart if markets do in fact fall back to the lows of 2002/03. At that point, authorities would be best served to open up the economy in a new and radical way to allow inward investment by neighboring SWFs. That means that the time may be close at hand when one of the biggest banks in Japan may be owned by the Chinese. Sounds crazy? The world is changing fast.

In the meantime, expect macro funds and multi-strategy players (mainly out of NY, London and HK) to continue to make directional plays on Japan especially if there is a further 20% decline in the Nikkei Index and a move in US$/Yen through the 79.75 all time high. At those levels central bank intervention is anticipated and likely, although for it to be effective will require the cooperation of the Bank of China and other entities that have been big buyers of yen and JGBS in recent months.

All told, the long-biased long/short Japan equity hedge fund is in for a rough final performance stretch in 2010. Expect asset losses.

When the Nikkei is close to 7,000-7,500 one might start to see again some of the world's biggest global investors including SWFs and petro-dollar investors pile back into Japan. The authorities would be wise to start preparing road-shows to encourage inward investments over the coming 12-18 months. Going long is about to be the right strategy in Japan - just not right now. Mahalo.

2010-08-24T08:43:00.001-07:00

China Diversifies Global Portfolio with Tilt to Asia

"Patience is the best remedy for every trouble."

Titus Maccius Plautus (254 - 184 BC)

Since the start of 2011, China Inc. has gotten quite serious about where it parks its excess capital. Recent data points to the act that the Chinese have been heavy buyers of Korean bonds and stocks over the past months. According to the Korea's Financial Supervisory Service, China has doubled its holdings of Korean Treasury bonds since the start of 2010.

China’s holdings of Korea Treasuries stood at Won 3.9 trillion (US$3.3 billion) as of late June, up more than 100% from Won 1.8 trillion at the end of 2009. China has also piled into corporate bonds buying Won 2.45 trillion over the first 6 months versus Won 2.76 trillion by the U.S. As of end July the Chinese entities held about 6% of outstanding Korean fixed income paper.

The impact of this may have long term impacts - some good and some not so good. Consider that the Chinese were widely considered to have been the most aggressive buyers of U.S. Treasuries since 2003/04.

This coincided with a time when global interest rates were already trending lower. It resulted in a continued period of low rates in the U.S. which went a long way to pumping up the demand for mortgages and so demand for housing and one of the biggest asset bubbles ever seen. Of course, what goes up must eventually come down, so that all of those negative NPV projects spawned by the low interest rate environment have had significant reverberations around the world.

So we can expect similar distortions to impact Korea's domestic rate environment. How can it not happen? Chinese entities are currently buying more than a net Won 300 billion of Korean Treasury securities on average (3-year and 5-year treasuries) every month. Knowledge of this buying pattern has resulted in higher demand, an increase in prices sending yields down. Local institutional investors such as insurance firms and asset management companies are jumping on the bandwagon too hoping to buy before the Chinese, driving yields down further!

As of Aug. 20, the 5-year Korean Treasury bond was down 0.11% to yield 4.13% marking the lowest yield since Apr-2009. The Korean 10-year bond was also 0.09% down to yield 4.55% while the 20-year was 0.08% lower for 4.66%.

This yield action is coming amid an environment in which BoK is expected to hike rates to cool down the strong economy. Remember, this how the story went in the U.S. with the Fed not really understanding why U.S. rates remained so low.

The culprit here is China's SAFE or State Administration of Foreign Exchange which effectively manages the country's vast and growing FOREX reserves.

China is the largest foreign holder of U.S. treasury securities,keeping a reserve of US$843.7 billion as of Jun-2010. These holdings decreased from US$900.2 billion in Apr-2010 to US$867.7 in May-2010.

With further dislocations in local interest rates coming, it looks like a safe bet that hedge funds should now aggressively start to trade Asia's sovereign and corporate fixed income paper. Mahalo.

2010-07-16T12:34:00.000-07:00

Best Performance Bet in Asia: Mining, Infrastructure & Private Equity

"Study the past if you would define the future."

Confucius, Chinese reformer & philosopher (551-479 BC)

With global hedge fund performance looking at sub-3% returns through the first six months of 2010, a critical decision facing institutional investors may well be to ramp up private equity and infrastructure investing.

While the juiciest deals may be full there remain a healthy and growing supply of mid-tier opportunities. Top tier firms are oversubscribed in today's environment after a period of lackluster involvement by western investors. Blackstone, Carlyle and Bain are all in capital raising mode looking at Chinese yuan-denominated deal. For example, in the three years from 2005 PE fund raising rose from $2.1 billion to $12.2 billion.

Meanwhile, retail investors are parking their money in FX (the Yuan is a one way bet to appreciate) and high yield fixed income - which typically means the Asian bond markets where they can get relative certainty of return in well run companies.

That said, regardless of the state of the secondary markets in the region, straining infrastructure investments needed by rapidly urbanizing countries such as India and China may prove to be the better way to maximize investment NPV and IRR levels over the 30% territory.

Aside from toll roads, bridge-building and car parks there is the distribution and trade infrastructure such as port and storage facilities that will need to be funded, built and upgraded in order to provide the growing middle class population with imported foods, consumer and capital goods. These are simple macro issues that will need to be resolved. And while the investor's money may be held up in more illiquidity the payoffs are likely to be more consistent and predictable, features that make them very attractive for the region's institutional investors, SWFs and western firms too.

As part of this trend, commodities and especially the mining sector is one of the hottest places to be. According to data compiled by Bloomberg, commodity companies have announced US$362 billion of takeovers. Resource deals account for 28% of this year's US$1.26 trillion M&A market. This is twice their average share over the last 10 years.

So clearly, money flows will not be heading to Japan, as they did in the 1970s and 1980s. In fact, Japanese institutional investors (in particular, the public pension funds) should be entering a period of significant capital deployment throughout Asia, with an emphasis on scalable, high yielding project growth such as nuclear reactors, power stations and mining deals.

An ETF that invests in Asian infrastructure deals and or private equity projects might be sure-sellers to retail. Good luck to those firms that are shrewd and quick-witted enough to get that branded product to market first! Mahalo.

2010-07-01T16:39:00.000-07:00

Tough Long/Short Asia Times Coming

"The Markets can remain irrational longer than you and I can remain solvent."

John Maynard Keynes, British economist (1883-1946)

Global stock markets have started the first six months of 2010 on a very tenuous footing. Within Asia in particular, and per MSCI/BARRA data on a YTD basis, stock market performance has been largely negative: Australia -19.21%, Hong Kong -5.33%, Pacific ex-Japan -14.67%, Japan -3.53% and Singapore -3.43% to name a few.

The performance picture across hedge funds that trade Asian markets has also been largely disappointing. Most "winners" rode higher the spotty positive beta performance of Japan, only to suffer in May when the so called "risk trade" was taken off and monies fled stocks and flowed into U.S. Treasury bonds as a safe haven as well as into gold. Australia took it the hardest as the incumbent government made a high profile campaign to impose a stiff surtax on mining company profits.

According to the mid-June data accumlated on a number of hedge funds tracked by HSBC Private Bank in their Hedgeweekly #26 report, the average performance of Diversifed Asia equity funds was -1.53%, with some in China taking a particularly hard beat-down as the policy makers there have taken an increasingly hard line against inflationary pressures in on the lending side. This has inevitably led to a modest downward revision of domestic growth and production projections, which in turn has led to downside revisions in stock prices in the public markets.

That said, there have been a few positive stalwarts such as Bob Karr's $2.1 billion Joho Fund Ltd. which was +7.79%. Japan equity diversified funds returned +1.48% led by the Henderson Japan Absolute Return Fund Ltd +7.09%, while some bigger global players like Brevan Howard's Asia Fund Ltd returned -0.36%.

On a global basis, clearly there is still a lot of macro factor correlation with developed markets (which suffered heaviest over th elst 6 months - led by Europe). This goods and services correlation continues to bleed into the portfolio asset markets making the waves in Europe and the US still hit the shores of Asian markets. It will continue to do so, until, at least those emerging economies have a significant scale of domestic private spending and consumptoin driving their production engines. We are probably still a good few years away from that, although the time will come.

Until then, as developed stock markets continue to meander lower, the risks remain that Asian markets and in particular hedge funds with long/short equity biases will also go lower in terms of performance. Now more than ever, all firms need to establish differentiated marketing plans to grow and retain assets with a particualr emphasis on capital preservation. If not, they can look forward to a bleak capital raising future. Nuture long term, institutional investors. Mahalo!

2010-06-02T09:13:00.000-07:00

Disappearing Act: Where'd the Uncorrelated Alpha Go?

"It is better to fail in originality than to succeed in imitation".

Herman Melville, author (1819-1891)

Preliminary hedge performance numbers for May 2010 are unsettling. And the conclusions are not directed at Asian hedge fund managers alone but can be applied more generally to single managers. I won't even start to include the 'dying breed' of hedge fund of funds (FoHF) here and perhaps investors will start to actually do some homework.

First, so much for absolute returns! Across virtually all asset classes, hedge fund returns are likely to be down around 2.0%-2.5% for May as the combination of swift trend changes in currencies, energy, commodities, fixed income and stocks and to a lesser extent credit negatively impacted many managers. This would be the worst monthly performance number since Nov 2008 and would break a positive performance string of 14 months according to the Credit Suisse-Tremont Hedge Fund Index. Whatever happened to protecting against the downside?

Second, it appears from the early-initial data, that the larger multi-strategy names as well as mega-large, concentrated single strategy funds (e.g. Paulson) suffered particularly badly. We may be seeing the beginnings of a tough time for big-and-unwieldly funds as they try to navigate what may become more volatile market conditions which were augured in with the "flash crash" of early May. They may not be too big to fail, but rather too big to generate performance efficiently and quickly enough. They must rely on economies of scale and big directional bets rather than nimble day-trades.

Third, an increasingly common thread here is the fact that as traditional indices go, so go hedge funds. This was the story of 2008. Back then, after a long trending period in credit, equities, fixed income and commodities hedge funds suffered a similar breakdown heading into the end of 3Q2008. Many hedge fund strategies fell victim to losses partially due to the common complacency investing in crowded trades (banks stocks vs commodities) and that may be happening again. This author recently saw hedge fund strategy level correlations against the MSCI World Index and they were particularly high (see most recent Lipper Hedge Fund Insight Report).

Forth, the dispersion of performance returns appear to be rising for macro and managed futures strategies. By implication then, a falling or static performance dispersion pattern on a month-on-month basis across other strategies suggests a higher correlation among those strategies and so lower diversification for those investors that have little or no weighting to macro and managed futures.

This means that one can expect many hedge fund investors to have suffered steep losses in May. It is important to note there that it is not the absolute level of returns that is important as much as the dispersion of those returns within the specific sub-strategy universe. It is a subtle point.

These general hedge fund insights suggest that the educated hedge fund investor should take even more care in picking a mix of managers by size (being big may be a hindrance) and also by strategy.

The latter point would suggest less of a reliance on multi-strategy approach which might be particularly susceptible to low dispersion and higher correlated returns to its own peer-group as well as to traditional indices. Keep an eye out too for niche macro and managed futures managers, even in Asia, that might be able to weather more volatile market storms that lie ahead. There is still uncorrelated alpha out there. It may be just more difficult to find. Simply keep on looking. Mahalo.

2010-05-20T09:06:00.000-07:00

Coming Soon: The Biggest Institutional Investor in the World - Japan Post

"What counts is not necessarily the size of the dog in the fight - it's the size of the fight in the dog"

Dwight D. Eisenhower (1890 -1969)

The wheels are in motion, and in Japan and elsewhere people are looking and expressing concern. Why? The reason is as follows: Japan Post (a Japanese state entity) will become a "private" operation called Japan Post Bank Company .

Already the single largest deposit taker in the world it is looking to double those assets, eating away at the competition, before moving (inevitably) into the lending business. Japan Post Bank Co. currently weighs in with a massive $3.3 trillion in assets comprising approximately $2.1 trillion in savings accounts and $1.2 trillion in life insurance policies.

Critics of this "supertanker deposit bank" include onshore Japanese banks, city banks, regionals and brokers. Surely this interloper with cheaper deposit base would be in a great position to "steal" away business especially as their assets were built up at subsidized borrowing costs.

Overseas, the U.S. and Europeans have already made noises at the WTO as they too are worried that this new operation will easily move into any financial market it wants and effectively beat out the JP Morgan Chase and Citis of the world, that are currently under attack from their own domestic regulators.

The battle lines are being drawn. Of course, this organization already is (secretly) a massive players in the fixed income markets effectively backstopping the lousy returns of the JGBs. It has also been a big player in the U.S. treasury market and less of a player in equities due to the excessive volatility and risk of principal loss.

However, that might change especially as the vast amount of assets Japan Post Bank controls is effectively the savings of their rapidly aging population. Once there is greater clarity as to the type of market-based operation and strategy it will pursue (no clues as yet from a vague and politically correct website www.jp-bank.japanpost.jp/en_index.html) what we might see is the beginnings of a new and substantially powerful quasi-SWF force out of Japan, one that will inevitably be a big player in the passive equity investments , fixed income and alternatives including hedge funds.

Whether Japan Post Co. can suceed will depend on its independence as well as the quality of its management. Hopefully, Japan Inc. will not make the mistake of manning it with "old timers" or Oji-Sans whose primary skill is in playing politics and taking favors and not building sensible businesses with rationale investment decisions based on positive NPV project analysis. A rare opportunity is approaching.

According to a recent communication between Japan Post Bank Co. and the BIS (http://www.bis.org/publ/bcbs165/japanpostbank.pdf) the fact that the former invests very heavily in Japanese Government fixed income instruments which it considers risk-free means that it has (so far) side-stepped any issues related to leverage on those investments.

A logical suspicion is that Japan Post Bank Co. has a lot of its balance sheet invested in leveraged JGB products. Unfortunately, in light of the recent issues related to international sovereign debt exposure and bank balance sheets, this may become a very real short-term problem as the latter may soon be forced to look for alternative risk-free asset investments if BIS rules on banks start to redefine more clearly how much these investments can be leveraged and what that means for capital requirements going forward. U.S. Treasury securities here we come? Mahalo.

2010-05-14T15:21:00.000-07:00

Dollar Carry Not Yen Carry - The Most Important Trade of 2010

"You can avoid reality, but you cannot avoid the consequences of avoiding reality".

Ayn Rand (1905-1982)

In the midst of a sudden burst of volatility across a number of asset classes over the last four weeks, one is reminded of comments made back in January 2010 by the Deputy Governor of the Bank of China.

He said, in what may be fast becoming a trading reality for a number of hedge funds, prop shops and SWFs, that the biggest risk to the global financial system was the unwinding of a dollar carry trade.

The scale of this unwind (rumored to be in the order of $1,500 billion) would manifest itself in a sell-off in so-called risky assets like emerging market currencies, equities as well as commodities (like copper) and more recently the euro and yen. The fundamental basis for this unwind purports that the U.S. would lead a global tightening in interest rates and that this would turn the U.S. currency into an investment as opposed to a funding currency.

The problem with this thesis is that the Federal Reserve has stated that the Fed Funds rate will remain low for an extended period. In the meantime, other central banks have tightened, namely: China, India and the RBA. So what we have now have is the dollar being bid-up as a safe haven in the face of geopolitical and sovereign debt risks with investors again being sucked into the U.S. Treasuries as the only "riskless asset in town".

However you cut it, the U.S. dollar is likely to continue its medium term assault higher sucking in global portfolio flows away from potentially more attractive NPV projects in the BRICs and emerging markets in general. Confirming this, recent Treasury statistics for March 2010 showed that overseas investors (including the Chinese) have increased their appetite for U.S. stocks and bonds by a combined $140 billion. This was a massive $93.4 billion over February. The bulk of these flows have headed to "riskless" U.S. Treasuries, to a lesser extent stocks and even back to illiquid U.S. real estate projects.

In the long run though, a shortage of available global riskless assets is a BIG weakness in the global financial system, and may warn that the market turnaround in rates will make the inevitable outflows all the more vicious and destablizing.

With trends now clear and present across a number of asset classes expect macro, multi-strategy funds and managed futures hedge funds to enjoy a period of solid, albeit volatile returns, while the outlook for long/short equity managers may be a little more difficult as equities zig-zag lower as the global "w-shaped recovery" takes shape and sluggish growth and persistently high unemployment takes root.

A supplementary point to the above observation, is that the U.S. Treasury bond market which is benefiting greatly from the current rush of safe-haven capital, is likely to snap higher once the deteriorating state of the fundamentals take shape. Maybe the dollar moving higher will choke off some of the market share that large U.S. multi-nationals had been making recently in overseas markets, including in Asia. It is all worth watching with volatile, bated breath. Mahalo.

2010-04-29T13:01:00.000-07:00

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.

2010-04-29T08:50:00.000-07:00

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.

2010-04-26T06:54:00.000-07:00

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.

2010-04-21T06:53:00.000-07:00

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.

2010-03-05T06:55:00.000-08:00

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.

2010-03-04T09:01:00.001-08:00

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.

2010-02-25T13:37:00.000-08:00

Going Long Is So Yesterday

"True originality consists not in a new manner, but in a new vision."

Edith Wharton (1862-1937)

Well done Boyer Allen! You have decided to tread in the considerable foot-steps that were first laid out many years ago by hedge funds the likes of Maverick, D.E. Shaw, AQR and numerous others. When the biggest issue related to growing existing institutional portfolios is that you do not have any long-only product why not create your own by simply decoupling your long/short equity offering and entering the space.

The trouble with this strategy is that the manager is now in the "margin vs. volume game" offering long-only, low margin products. It also now pits his product with a larger field of competitors, and guess what, those long picks might not outperform their respective active manager mutual fund peer group after all. Wouldn't that be ironic.

By effectively chasing beta, managers like Boyer Allen are conceding that it has been tough sledding gathering assets from institutional mandates in the post Credit Crunch world. After a period of poor performance that many suffered in 2008 it also raises the question whether investors are better served adopting the cheaper, passive ETF route than the expensive, active manager route that often fails to match the returns of the passive index on the upside.

Critically, the decision by Boyer Allen and other Asia equity market specialists is one of diversification and having a product that can sell regardless of the market cycle. They may be better served blending hedge and long-only products in "new ideas" rather than to churn out ideas rooted in active management that is fast being superceded by low-cost passive alternatives. Time for hedge fund managers to get creative and develop interesting, better performing ideas rather than changing the wrapping! If not, they will suffer from critics who contend that they are more often levered beta factories. Maybe they should simply focus on being better alternative investment in the first place. Mahalo.

2010-02-23T12:27:00.001-08:00

Global Multi-Strategy Funds Target Asia: Coming or Going?

"Such is the inconsistency of real love, that it is always awake to suspicion, however unreasonable; always requiring new assurances from the object of its interest."

Ann Radcliffe

author & benefactor of Harvard, 1764-1823

The hedge fund industry carousel is back in full swing. With well-known media outlets reporting in recent weeks that the world's largest multi-strategy hedge funds are looking to open up offices in Asia should one assume that this portends another Golden Age of industry growth? The short answer is perhaps, while a long term answer is less clear.

The first time around, in the 2003-05 time slot the main driver was Japan. At that time the macro play for many of these players was made available by the BoJ backstop to the Japanese banking system. At that time with the prospects of nationalization not on the cards and the government priming the economy (albeit temporarily) there was a wave of activity in M&A, investor activism, IPOs and overall volumes of equity contracts traded on the TSE, Osaka and on other regional exchanges.

Famous names like Citadel and SAC routinely accounted for 3-5% apiece of the market cap of all stocks traded on the TSE across most sections. In fact, many of these global funds typically accounted for close to 60%-70% of all capital in Japanese equity markets. A common misconception had been that most capital came from Japan-specific long/short funds.

At this time too, Japanese banks making road-shows in the U.S. and overseas also started to visit hedge funds in order to find out what motivated these "new and active" stock investors in their own stock and in the markets in general.

Fast forward seven years later. Japanese stocks are anaemic with slim prospects of any rebound. The national finances are a mess with debt levels at historically high levels. There are few to no IPOs and activism is dead. The nanny state has taken over and yet high taxes and bureaucracy remains an unsavory way of life. And for stock pickers Japan remains the archetypical "value trap". So what are these managers chasing?

This time around, big names like Moore Capital, Maverick, Stark and Viking are looking at China, Hong Kong, Indonesia, Singapore, Malaysia, India and Australia prepping for growing equity markets, potential M&A opportunities and large scale event driven: distressed security plays. Chances are, they are not looking at Japan!

The fact is that many have already been in Asia and closed up their offices in some cases less than 24 months ago. But now, with the prospects in the U.S looking less than stellar heading into a double-dip recession it is as much a reaction to the lack of potential opportunity in the U.S. that is seeing this renewed interest overseas.

It remains to be seen if this is another temporary interlude before even these Asian markets start to have their own "bubble blow-ups". In the event that happens, watch for money to flow very quickly back into the most liquid instruments in the world - U.S. Treasuries - while the night desks in New York and London start whirring again as the lights are turned off again in Hong Kong and other regional locales as these big shops look again to protect their respective bottom lines.

As we have preached before, Asia-based exchanges and monetary authorities should be looking at this opportunity to increase transparency, improve access to hedging instruments, kick-start local fixed income markets and to lower transaction costs and paperwork for many of these necessary liquidity providers. If not, many of these hedge funds that are coming will soon be going. Mahalo!

2010-02-10T06:14:00.000-08:00

SWFs Going Single

"The perfect bureaucrat everywhere is the man who manages to make no decisions and escape all responsibility."

Brooks Atkinson (1894 - 1984)

The future of sovereign wealth funds (SWFs) in the single hedge fund business model looks bright. Reports from Bloomberg that Temasek Holdings, the Singapore-based investment house is about to launch a fund of its own should come as no surprise. Combined assets of the 60 or so global SWFs topped $3.8 trillion in 2008 with an additional $5.5 trillion in pension reserve funds, development funds and state-owned corporations.

Before we consider this as new money entering the business (as presumably they are in the best position to seed these new ventures) a better assumption may be that they are simply reducing their allocations to HFoFs. The reason for this may be related to: the bad performance of a vast majority of HFoF vehicles in 2008 (down at least 20%); gating and fee issues; and, the fact that many of these operations have now recruited a vast number of skilled individuals (mainly from multi-strategy single managers) and are now in a position to replicate those models on their own dime (or euro)! This cannot be underestimated.

Going single makes cents. It drives out the HFoF middle-man, it captures more of the hedge fund value-chain, and it could also lead to additional fees generated as some of these SWFs extend their models into the distribution of financial instruments.

The Asian opportunities are vast. With considerable financial muscle behind them it is conceivable that many of these SWFs will get access to illiquid or distressed, or even private equity-type of deal flow in the equity markets. Of course, to make this really scalable it requires that there be a massive upgrading in the exchanges and the hedging instruments offered not only in equities but also in fixed income as well as in derivatives. If not, this money will inevitably chase the limited number of deals in the developed world which though liquid, tend to offer a lower return on investment. In this instance, do not be surprised if these SWFs step up their activity in the ETF markets using leverage.

An interesting development will be how the international monetary authorities react to monitor the activities of SWFs across various markets such as recently via big positions in oil ETFs on NYMEX or in grain markets.

It may not be too long before the biggest and most aggressive multi-strategy funds in the world are those run by SWFs, and not traditional players like Citadel, D.E. Shaw, Soros or many others. The key will be to find a set of scalable investment strategies, which is no mean feat! Mahalo.

2010-02-08T06:21:00.000-08:00

Asia's "Berkshire-Blackstone Octopus" Extends Reach

" I owe my success to having listened respectfully to the very best advice, and then going away and doing the exact opposite."

G.K. Chesterton, English writer (1874- 1936)

China Investment Corporation (C.I.C), arguably the biggest hedge fund and sovereign wealth fund in Asia, was recently revealed to be bulking up 4Q2009 assets on U.S. equities. The state-controlled operation which manages upwards of $2 trillion in China's growing forex reserves has been buying stakes in U.S. blue-chip companies many of which are liquid, and likely winning multi-national firms as the growth of the middle class consumer takes hold in the BICs (Brazil, India and China).

The $9.6 billion investments bring to light a new approach in the effort to diversify their U.S. exposure which up to now is/was focused almost exclusively on U.S. Treasury securities. It is a way to "recycle" their foreign exchange earnings which is becoming a very political issue these days. This is good news for the U.S. beleaguered stock markets that have been worrying about who has been buying at these elevated levels. Now we know.

The move also marks continued move away from relying on so-called foreign expertise by moving through large U.S. buyout/hedge fund or banking institutional intermediaries and to go direct in managing national assets. Expect more moves in coming months/years to take stakes in commodity trading operations, shipping companies or even trading exchanges as Asia's dominant SWF finds ways to exploit its growing "buyer power".

CIC will effectively evolve into some hybrid of a Berkshire Hathaway-Blackstone Octopus conglomerate with a footprint in every continent as it lays a foundation for China Inc. industrial foray abroad. They might want to consider hiring a U.S./European advertising company to grow a kinder-gentler global image too. Mahalo.

2010-01-26T08:55:00.000-08:00

Expect Slow Trickle Not Flood of Prop Desk Spin-offs in Asia

"You may not realize it when it happens, but a kick in the teeth may be the best thing in the world for you."

Walt Disney, entrepreneur & film producer (1901-1966)

Obama's recent Volcker Rule that aims to restrict risk-taking by banks will face challenges as the legislative process gets underway. The actual rule in its initial form may force banks to drop out of prop trading, running hedge funds or HFoF and even private equity operations for their own account. It might also extend to shops like MS and Goldman, Sachs - traditional prop shop power houses.

But one thing is sure - if U.S. banks and a large number of European ones do follow through on the Volcker Rule then it might spur a large number of spin-offs of current prop trading (equity/fixed income and derivative-related) operations in Hong Kong, Singapore and Tokyo currently attached to these banks.

While the balance sheets of these entities certainly helped to scale up these prop trading operations, a clear implication will be to expect and to see a fall-off in overall volumes of instruments traded either off balance sheet or even on exchanges.

Exactly what the scale of this potential prop trader migration will take is unknown. It will certainly differ from country to country and from firm to firm. Clearly, it will lead to some movement to large multi-strategy multi-national firms like the Och Ziffs and Citadels of the world, although they may already have a stranglehold on the best trading talent in the region. It may also open up a whole new talent pool to the large Japanese banks and brokers looking to build up their presence in these once profitable areas. It might also look a little "bad" if there is a flood of talent given how some of these teams were brought on board at considerable cost in the wake of the Lehman Brothers demise.

Another area where there could be action is likely to be among the HFoF community. A small number of these U.S. banks may still have on-the-ground analysts and marketers in Asia as they look to build globally diversified portfolios along the lines of the JP Morgan Asset Managements of the world.

If there is value out there these FoHFs may become subject to MBOs, M&A activity or they may simply dissolve as key talent runs to other firms. As an idea at to the size of this opportunity, consider that a consultant (Prequin) recently estimated that the 19 FoHF units of U.S. banks account for around $180 billion in AUM. In my opinion, these bank operated HFoFs tend to have been the worse performing vehicles relying for too long on their name brands and distribution channels to move product. The days of the mediocre HFoF in Asia may really be over.

Whatever the result, The Volcker Rule may have implications as far away as Tokyo as the boards of major banks crank out business plans and reports to try and prepare for how they too will try to take advantage of the current opportunities. Expect many implications for current business practices and new ones too that will impact other associated industries like insurers. There is no doubt that consultants and headhunters will be working the phones actively and profitably in 2010! Mahalo.

2010-01-26T06:56:00.000-08:00

The New Normal Marketing Hedge Funds in Asia

"Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy, its inherent virtue is the equal sharing of misery."

Winston Churchill, U.K. Prime Minister during WWII & author (1874-1965)

2010 has just kicked-off and the world of hedge fund investing has turned on its head. The following generalizations are well known but not yet explored as the mass media tries to paint a "return to normal" image of an industry fully recovered from the credit crisis, scandals and gating issues of 2008/09.

Here are some of the still apparent realities in the New Normal world of the hedge fund industry:

As many as 70% of all hedge funds (approximately 7,000 fund firms) still have not recovered their high water marks following 2008 average losses of 25-45%.

This one is anecdotal. As many as 50% of all hedge funds, have not been paying staff or partner salaries over the last 6-months as typical hedge fund firm cash "burn rate" accelerated in 2009. This has hit firms with AUM under $200 million and is in spite of the +60% equity market run-up since March 2009.

A still large number of funds will close as partners throw in the proverbial towel on subsidizing the fixed costs of their funds. There comes a time when enough is enough! Expect more "early retirement" stories over the next 6-9 months.

A still indeterminate (yet significant) number of investors remain "gated" in illiquid investments following 2008 losses, and they still cannot get their money out. In many cases, investors are still being charged fees on these trapped assets!

A new and important DDQ question that investors are implementing en masse is simply: Did your fund make a profit or a loss in 2008? If the answer is a loss the fund will not get any allocation. This appears to be a hard and fast (and yet unspoken screening rule) that many institutional investors have been implementing so far since 2009. The bar has been raised.

The hedge fund of fund industry is in REAL trouble. As a whole, assets are bleeding as investors either sit on the sidelines or go direct to single managers. Considering this category used to make-up over 30% of all investors in single managers you imagine how the typical buyers have vanished from the scene. You can imagine too what this has meant for all those specialist marketing staffers who used to service HFoF, HNWI, family offices, private banks and endowment) niche? You guessed it - they are being let go in record numbers as the underlying fund firms try to find a fresh set of rainmakers.

To all extent and purposes no hedge funds are closed anymore. None. Provided you are considered deep pocketed and long-term (i.e. institutional). This marks a big change from 2007 and explains why the bigger multi-strategy funds are hiring these gatekeepers to the institutional investors or other gatekeepers (consultants).

Latin American and Swiss investors have not made any meaningful allocations since the end of 2008. It may take another 12 months before they return. Such has been their collective losses/embarrassment in the wake of Madoff and other scandals. The streets of Rue de Rive and Bahnhofstrasse are quiet. Mahalo.

2010-01-18T09:20:00.000-08:00

Regulatory & Tax Arbitrage (Not Markets) May Spark Asian Hedge Fund Industry

"The Secret of creativity is knowing how to hide your sources."

Albert Einstein, physicist (1879 - 1955)

Caveat Emptor. The apparent shuffling of feet you might hear of large global multi-stratregy shops moving back to Asian financial centers is not a direct result of better risk/return investment opportunities unfolding in 2010. This author believes that it is best thought of as a regulatory and tax arbitrage play facing threats from existing centers, and in particular in New York and London.

Asia long-only the way to go? Over the last 4-5 years many global institutional investors have pulled back from hedge fund long/short strategy investments in Asia and have instead sought low-cost beta alternatives such as through ETFs. Returns from MSCI Emerging Market Index +70.31% in 2009 certainly look attractive, but are tempered by the 2.64% return over a 3-year period. Likewise, the MSCI Asia Pacific Index gained +134.46% in 2009 but was -5.01% over a 3-year period and the "dog" of the group, the MSCI Japan Index, returned 6.68% in 2009, but was down -11.15% over a 3-year period.

HNWI and fund of hedge funds have also "abandoned" Asia to a large extent. Many of these investors chsed the +20% returns that many smaller managers boasted. These investors used to be the traditional supporters of new and growing funds in the region and a few years back there were close to 80-90 hedge fund of funds with an Asia-focus. Not anymore!

Sadly, the risk/return profile of many locally-situated managers have been constrained by the realities of: capacity constraints(around $400 million and the typical fund woulkd face stock-borrow "issues"); an inability to produce positive returns on the short-side of their books especially when the markets go down; and, the uncanny realization that being in Asia does not a good hedge fund manager make. There is no extra advantage, unless you are an activist and rely on local connections and ideas to source investments.

With a few large multi-strategy shops opening up in Singapore and Hong Kong some sort of investment renaissance may be underway. This may yet be the case although until we see new funds and a high number of start-ups (which is not yet the case) I believe that it is rather a play to potentially arbitrage existing assets and taxpayers out of potentially "painful regimes". This may be worth looking at closely in the next 6-12 months and should gather steam as the U.S., U.K. and European authorities come down hard on hedge funds as part of their overall promise to the taxpapying public to fix the existing financial regimes.

New instruments, tax breaks & insitutional investors. What really is needed are new hedging instruments, tax breaks to lure in fresh talent, the dismantling of bureaucratic rule to set up a fund and growing allocations by local institutional investors to back local hedge fund talent. Failure to do so will result in yet another wave of temporary not permanent interest in hedge fund strategies in Asia. Mahalo.

2010-01-06T05:44:00.000-08:00

Asia Hedge Funds Bounce Back But Still Underperform Long-Only

"The only thing that you owe the public is a good performance."

Humphrey Bogart, actor (1899-1957)

Data from HSBC Private Bank, Alternative Investment Group (Hedgeweekly #53) suggests that a healthy number of Asia dedicated hedge funds ended 2009 on a positive note, although maybe not a relatively high one when compared to long-only alternatives.

By category, multi-strategy players ended the year close to an average of 4.99%, in large part driven by the reinvigorated performance of George Long's LIM Asia Multi-Strategy Fund Class A which through Nov 30 ended up 18.78%. In contrast, the Dec 18 number for Richard Margides' Artradis Barracuda Fund limped in at a -11.92% as his heavily volatility-based strategy back-fired throughout 2H09. When compared to global multi-strategy managers this was very poor as HSBC points to an average return of 16.74% (largley on successful bets in credit and convertible arbitrage instruments).

Diversified equity (which typically implies long/short) in Asia put up a credible 17.94% in 2009. Leading performance managers included Boyer Allan's Pacific Fund Inc (A) which posted a 35.07%, Ezra Sun's The Real Return Asian Fund Ltd was up 37.29% and Richard Chevenix-Trench's SR Global Fund B was up 29.37%. The latter is notable as it is a fund (like Joho) with assets over the billion $ mark. Sadly, the relatively small size of many Asian funds continues to put a cap on their ability to attract significant institutional assets which, by definition, will tend to herd towards the bigger US and European managers that might have Asian exposure through their night-desk operations.

The weakest performers in the HSBC listing in the diversified equity Asia, were Kyung Hwa Park's Corevest Partners Limited at --0.34% through Dec 11 and Alex Lewis' MBAM Pan-Asian Fund Ltd at -0.32%. Both funds had assets just over the $100 million mark.

Among diversified equity Japan managers the performance picture was mixed. Average fund performance through 2009 was up 4.06% led by Bob Macrae's Arcus Japan Fund (Yen) which was up 30.70% as of Dec 29 as well as a solid bounce back year by Mike Hill's Blue Sky Japan Ltd which was up 24.46% as of Nov 30. In contrast, Hugh Sloane's SR Global Fund H - Japan was down -19.25% while Warwick Johnson's Optimal Japan Fund C1 suffered a -9.20% decline. Of note, aggregated assets in Japan among this strategy fell sharply year-on-year and continues a trend that appears to have set in since 2006/07 of bleeding assets as performance slides.

The poor overall performance of Japanese equity markets is worrying on a number of levels - especially as alternative geographies in the region may attracting an increading portion of discretionary portfolio investment assets. As long as many long/short managers in Japan have high drawdowns, investors will be right in questioning the effectiveness of risk management and the ability to short.

In the multi-strategy Asia category, Bennelong Asia Pacific Multi-Strategy Fund Ltd. was down -17.47% while PMA Asian Opportunities Fund was up 6.02%.

Of course, some institutional investors are not blind to the incredible bounce back that stock markets endured from March 2009. For many of them exposure on the long-side through low-cost ETFs via astute tactical allocation paid off handsomely. Just looking at the trough to high point performance of many of these liquid ETFs may in fact tell the real story about Asian hedge funds asset losses through 2009: Japan +149%, Hong Kong +186%, South Korea +238% and India +368%.

For many investors, going long-only Asia (as with emerging markets in general) was the big winning strategy in 2009 and potentially for 2010. Who knows? Mahalo.

2010-01-01T11:40:00.001-08:00

The Indian Connection

"India is an abstraction...India is no more a political personality than Europe. India is a geographical term. It is no more a united nation than the Equator."

Winston Churchill, speaking at the Royal Albert Hall, London on March 18, 1931

Churchill's comment was embedded in a colonial era long past. He could not have forseen how the world would change - the English empire collapse in full force by the 1960s and how the tech boom of the 1999/2000 era would vault the Indian economy and its skilled workforce into the limelight.

In the hedge fund space, Indians have become a powerful intellectual and economic force. Of approximately 400,000 or so employees in New York alone in 2003/4, this author estimates that as many as 10-15% comprise American-Indian workers. So they make up an important employee pivot point underpinning the whole industry.

Briefly, Indian's impact in the workforce quickly moved out of the I.T. programming back-office into the trading and dealing arena to running hedge funds by the late 1990s.

Of course, the recent notable illegal trading accusations aimed at the CEO of Galleon, a long short equity hedge fund manager, brought to the fore just how powerful and meaningful the Indian diaspora has become in the industry, especially when it comes to information networking in certain strategic and associated industries.

And given the large number of high qualified Indian graduates emanating from top-tier Indian and western business schools it is not a stretch to assume that over the next 10 years the number of Indians in the hedge fund industry will increase to 20-25%?

This should not and cannot be ignored by those interested in increasing the numbers of highly skilled (and highly paid) workers into a prospective financial workforce. Certainly, every global location should be paying attention, including those locations that are not necessarily on the list today.

Of course, it impacts immigration policy among other things so don't be surprised to see increasing numbers of Indian I.T. professionals getting visas to work in Switzerland. Of course, the Japanese should be doing the same to encourage a "brain/talent-flood " into their own moribund financial industry!

The demographic change ignores the additional impact that India will inevitably have as a source of alpha (as markets continue to de-regulate) as well as being signficant institutional investors. The first stage will be their impact through funneling the signifcant wealth of Indian entrepreneurs, industrialists and foundations and endowments.

We might be talking about as much as $3 trillion in investable assets. The Indian Summer for the hedge fund industry may already be here, with a Chinese version not too far away. Mahalo.

2009-12-29T11:24:00.001-08:00

2010 Through the Asian Looking Glass

"Always bear in mind that your resolution to succeed is more important than any one thing".

Abraham Lincoln (1805-1865)

16th President of the United States

Bear with me...recently, as I do this time of year, I put down a few random thoughts on the upcoming year and the hedge fund industry in general and send it to a few close colleagues for critical feedback. The beauty of making forecasts is that you can keep on making them, just like speculating on the weather. Anyway, I am taking the broad ideas and liberally applying them to the Asian hedge fund industry - which I sense is undergoing a radical shift.

1. Asset Growth. Global hedge fund industry assets were estimated at $1.55 trillion at the end of September 2009, rising to $1.87 trillion at the end of December (source: Lipper). This number is likely to grow to $2.16 trillion by the end of December 2010, implying a growth rate of 15.34%. As the rate of Asia assets has tended to be in the 20-25% range we can expect assets to grow from about $450 billion at the end of December 2009 to $510 billion by the end of December 2010. Asian assets fled at a faster rate in 2008/09 due to the "hot money" mentality of many investors and their high exposure to Madoff feeders.

2. Managed Accounts Emerge. Managed accounts with single managers will double for the global hedge fund industry in 2010. Assuming December 2009 assets at $300 billion, it is logical to expect growth to $600 billion by the end of December 2010. It is the marketing pitch du jour among hedge fund of funds and this will permeate down to the single manager level keen to gather lumpier and stickier institutional hedge fund allocations. A similar growth of demand among Asian institutional investors is more than likely given their respective experiences getting caught in "gated" fund situations in 2008 and 2009.

3. Hybrid Product Proliferation Challenges Hedge Funds. We are already seeing globally, a big push by mutual funds launching "hedge lite" products; the proliferation of leveraged-ETFs; and the rapid growth of UCITS III-compliant fund vehicles. These will increasingly compete with hedge funds for the attention and allocations of institutional investors in Asia. An ongoing issue for Asian based managers continues to be one of proving that they do indeed offer alpha and not simply liquidity-driven and leveraged beta. The days of simply opening up shop and waiting for the cash to come rolling in are over!

4. Global Hedge Fund Investor Mix.I predict that the future high growth investors will be corporate, public pension plans, insurance companies, banks, smaller endowments, Asian private banks, and Australian institutions, and Scandinavian institutions. This is pretty important as institutional investors tend to focus on capital preservation, non-correlation and to a lesser extent absolute performance. I also expect a rebound in family office buying interest. In contrast, the so called low-growth allocators will be HNWI, fund of funds, big endowments and beaten-up Swiss private banks. The “swing” investor remains the Japanese pension plans and what direction they go in during 2010.

5. Demise of Hedge Fund of Funds. The Hedge Fund of Fund Supertanker (comprising approximately 33% of global assets) that hit the 2008/09 Iceberg continues to Sink. I expect a continued slow bleed of AUM as business model flaws exposed e.g. no real diversification; access to underlying managers not an issue today; how to justify double layer of fees…expect drop from being 30-40% of total AUM to under 25% in 2010; this will have a BIG impact on how product is marketed. Fees have already been compressed to 50-75 bps with no performance.

6. Multi-Strategy Funds to Find New Ways to Succeed. On the one hand, we can look to a loss of assets and some institutional support from those that gated investors in 2008/09. There is also the issue that many investors are now keen to de-correlate portfolios and so move away from illiquid sources of alpha.

On the other hand, many of these names remain the only ones big enough to absorb lumpy allocations across a concentrated set of strategies. Many of them also tend to outperform their peers in various hedge fund indices to the tune of 250 bps per year, while the best multi-strategy funds have tended to outperform average hedge funds by as much as 650 bps each year.

We have already seen an initial phase with those firms that understand they will not be able to remain persistent out-performers moving into the long-only space, as well as launching hybrid products as they chase the opportunities provided by closer relationships with their institutional investors or even going after retail. Remember that many of these mega-sized multi-strategy funds have lost substantial cost of capital advantages that demised with Lehman and the whole prime brokerage business back in late 2008.

Regrettably, there are very few Asia-specific multi-strategy funds and these are needed if significant assets will again flow into the region.

7. Portfolio Construction Changes. Expect more concentrated, non-correlated portfolios to be the best/highest performing absolute return vehicles e.g. Paulson. Also, look for counter-party risk to become a key variable in portfolio construction.

8. Strategies. Equity beta (especially international) will continue to be powerful in 2010, which means equity long short, event driven and macro should outperform, as will commodities and energy. When short-term rates start to move up fixed income arbitrage will again emerge from obscurity and gain significant AUM inflows.

9. Plain Vanilla Out – Niche In. The bigger institutional investors are already typically diversified so to make an allocation to hedge funds they will focus on niche/uncorrelated strategies.

10. M&A Will Step Up. Long-only investment firms will buy hedge fund/HFoF managers or bring in teams (PIMCO) to diversify their mix of products e.g. absolute return marketing “fad”.

11. There will be high profile big fund closings and numerous small new fund openings and if the equity markets continue to climb then look again for hedge fund IPOs to make a comeback (even though many of those managers typically have not been the best performers). It never real took-off in Asia although that does not mean that it may not become a source of activity among certain names...

12. The Role of HF Seeders will Grow. Demand for hedge funds continues to out-strip supply of “institutional quality” funds so seeders will grow in importance as intermediaries acting on behalf of these investors to achieve critical mass to absorb the still massive amounts of institutional assets that need to be put to work in ways that are not correlated to the global equity markets e.g. Arrow Hawk.

13. Performance: the average hedge fund performance will be 13-16% CAGR with average annualized vol. of 8-10% over calendar year 2010 which will I predict lag traditional equity market benchmarks as they have done in 2009. Investors will realize why pay fees to a hedge fund that produces 20% return if I can buy the ETF and get 30% even though the risk/return profile of hedge funds will remain intact. Mahalo!

2009-12-27T13:39:00.000-08:00

The Missing Link: Big Single Managers in Asia

"Sometimes one must travel far to discover what is near."

The Treasure, Uli Shulevitz, 1978

Moreso in 2010 than at any other time in recent memory, Asia lacks it own big hedge funds. Big hedge funds are important. They tend to spin-off successful smaller managers that tend to start out themselves fairly big (e.g. Treeline Capital from LIM Investments); they are immediately attractive to institutional investors; and, they are important to the long term sustainability of liquidity in Asia's equity markets.

The fact is that there are well over 100 funds with an excess of $3 billion in assets under management globally ex-Asia. In Asia alone this number shrinks to less than 10 funds and that includes private equity, activists and arbitrageurs. Since 2008 that number is starting to dwindle too. This is not to defend a big-is-beautiful-thesis but the fact remains that smaller funds tend to be susceptible to greater business risks, especially if a given investment stategy sours (see recent performance of Artradis Barracuda Fund...)

In Asia, the hedge fund industry needs "leaders". Good performing leaders should have an array of strategies and "product wrappings" (absolute return and long-only), they should be attractive to Asian and western institutional investors; they should have the capability to raise $5 billion in order to be classified as "big"and they should have a pan-Asian investment focus. To many managers have realized late in the day that being only Japan-only is not going to help you raise more than a few hundred million dollars in assets - and if you can, then there is a tremendous geographical concentration risk you are imposing on opportunities and in so doing the risk/return that can be generated.

The good news that end 2009 pan-Asia long short equity managers have been able to generate an attractive average return of 17.80% (HSBC Private Bank Equity-Diversified strategy covering 17 funds). The bad news is that in the recent bullish run this still lags many long-only ETFs, which also do demand 2-2o in fees!

Perhaps the wave of the future will be large private equity shops in Asia evolving into hedge funds. Also, there may yet be a role for the region's SWF entities to build up internal operations and ultimately spin-off those entities through MBOs in order to "create" the next wave of Asian hedge fund behemoths. The clock is ticking. Mahalo.

2009-12-26T19:52:00.000-08:00

Big Choices In Store For Asian Investors

"We shall not perish as a people even if we get our money supply wrong - but if we get our human relationships wrong, we shall destroy ourselves."

Rt. Reverend Robert Runcie, b. 1921 (former archbishop of Canterbury)

Heading into 2010 Asian institutional investors face decision time when it comes to hedge funds.

Who are we taling about? When one refers to the category of Asian institutional investors one refers to Japanese pension plans, insurance companies, agricultural coops and to a lesser extent city-banks, regionals and HNWI. Outside of Japan, we can include South Korean insurers, a few corporate pension plans, Taiwanese broker-dealers, Singaporian SWF entities, Hong Kong family offices, the HKJC and other foundations and last but not least Aussie supra-annuation funds - all in all probably close to $100 Billion in buying power back in 2007/8.

How bad was/is "the hit"? Trying to understand and quantify "losses" in hedge fund investments is very tough at the best of times. We estimate that approximately 40% of buying power was lost following the Volatility Shock of 2008/9. This has taken th ebiggest toll on the hedge fund of fund business which this author belives represented as much as 30% of total hedge fund of fund assets. For this reason, the hedge fund of fund business is in trouble. As many investors in Asia also had exposure to Madoff feeders and other notable blow-ups (e.g. Russell Investments FoHFs, Petters ABL product).

What next? Typical hedge fund products that have sold in the past have been "big brand names" offering risk/return profiles that can compete favorably with fixed income - nothing fancy, simply good, consistent positive yield, if possible sans-exchange risk. But the choices today are limited, either through the fact of gating among many so-called brand name funds in 2008/09 but also because even though global equities have rocketed since March 2009 the ficed income markets have become tough places to find yield without going out in duration or further along the low quality curve. Should investors now risk investing in long short equity strategies? Are the equity markets due to dip again short term? Is the U.S. Treasury market bubble about to burst? These are very relevant and tough decision that Asian investors have to consider, and are considering.

A new reality? The fact remains that the first half of 2010 performance is likely to be led by traditional long-only products are they have been in 2009. The fact is that even with average hedge fund performance up around 20% over 2009 this will lag the bounce seen across a number of long-only asset classes. This begs the question that hedge fund managers should be asking which is, can their strategies we repackaged in a way that takes advantage of long-only markets to offer greater upside potential without taking high-risk, concentrated bets. The answer is yes! Expect the new reality to include a new set of absolute return products that straddle the mutual fund and hedge fund worlds - ones that offers up different risk/return profiles and even different levels of leverage and fees too. many progressive firms are already marketing such products to U.S. and European institutional investors and they will no-doubt land in Asia very soon.

Exciting times indeed. Mahalo!

2009-06-12T06:48:00.000-07:00

Global Investors: Give Me Alpha (Plus a Premium) for Asia

"Competence, like truth, beauty and contact lenses, is in the eye of the beholder".

Laurence J. Peter (1919 - 1988)

Fact number one: the hedge fund industry has been bleeding AUM over the last 6-9 months and the downtrend is not yet done. For example, a recent Lipper Hedge Fund Asset Flows report for 1Q09 pointed to a loss of close to US$115.7 billion - the second worst quarterly outflow since 1994. A good portion of that was due to poor performance in addition to outflows from Asia due to risk-aversion among global investors.

Fact number two: a key, and forgotten point, has been the makeup of investors fleeing the industry en masse. The bulk of the investor base which amounted to as much as US$400-500 billion, came from hedge fund of funds (HFoFs) and high new worth individuals (HNWI). This author estimates that as much as 75% of the capital that flooded Asian hedge funds from the early 2000s came from this fickle investor base. For example, in 2005/06 there were an estimated 75 HFoFs with an Asian focus. Many of them are now closed due to poor performance and heavy redemption losses and they will not be coming back.

Fact number three: Asia-specific manager performance shows a high correlation to beta indices that are liquidity and momentum driven. This is again, a proven fact. Once liquidity (i.e. exchange turnover/transaction volume) declines then the ability to generate alpha also tends to decline as over 70% of strategy assets tend to be driven by the directional moves of the region's equity markets.

Fact number four: non-equity related strategies are capacity constrained. If you accept the previous point then it becomes clear that you will not get large single manager funds with $4-5 billion in AUM. And, these are the AUM you need in order to be attractive to larger institutional investors. It also means that the vast number of currently "profitable" hedge funds are likely to make impressive monthly % performance gains on low AUM, which is always a red flag.

Fact number five: if, one is of the opinion that the global equity markets may yet see more volatility on the downside, then Asia presents further risk, and whereas in the past hot money investors sought approximately a 5-10% premium on returns for going oversea, that might actually rise now that the recent Volatility Shock environment has shown global investors how correlated the equity and credit markets can be.

As a result, all the hot air about new strategies and new managers setting up in Asia should be taken with a large dose of indigestion pills. Global institutional investors are not enamored with alpha from Asia but rather with the beta potential, especially as it relates to growth in small and mid-cap stocks. The region's bond markets are still too small and illiquid while other strategies will tend to have a strong correlation to the overall global credit market conditions. This is why, unless there is a regional push to finance locally established firms, Asian managers will remain the poster children for orphan beta generators for institutional investors and for HNWI the opportunities will only be tempting if the manager can generate 2-5% net of fees per month. Mahalo.

2009-04-28T07:43:00.000-07:00

Institutional Investors May Offer Hedge Fund Lifeline, Someday

"If a house be divided among itself, that house cannot stand."

Mark (circa 50 - 100 AD)

New Testament Bible

Shakeouts are never positive if you are on the losing end. The steady drop off in liquidity among Asian equity markets indicated by falling turnover, market cap and the proportion of institutional investor participants spells continued BIG trouble for the hedge fund industry. The only hope may be for the region's institutional investors to take a lead out of the CalPERs playbook and "gang-tackle" the seeding business.

BoNY recently reported that Asian institutional holdings of global hedge funds are down 40% year-on-year through 2009. Most of the selling that took place was directed at hedge fund of funds. Similarly, AsiaHedge reported that out of the universe of funds that they identify, 129 funds closed down in calendar year 2008. This was roughly 25-30%. Moreover, the prospects for further closures and asset flight should continue especially with so many managers failing to produce positive absolute returns.

This is a serious issue for the hedge fund industry itself, service providers, services in general, tax revenues (which should now fall) as well as the standard of living of participants and their associated economies. Corporate boards are also no longer under the proverbial gun to deliver shareholder value now that the scrutiny of activist managers has waned.

What we should be asking is, whether the Volatility Shock that started in September 2008 was a cyclical event or an secular one. Too many ostrich in the sand "experts" couch their state of the industry analysis in terms of cyclical factors - "good for the industry...", "survival of the fittest"..."the industry will bounce back even stronger...". This is naive.

The battle for the regeneration of hedge fund industry in Asia has two sides to it. First is supply of alpha generating talent. This means a pipeline of new managers. Under the current environment of increasing overhead costs, bureaucracy and legal requirements for start-ups the barriers to entry were raised for 2009. It will take over $100 million for an ongoing concern to survive a couple of market cycles, as well as to attract any long-term desire for institutional assets.

If you thought that there was a shortage of quality talent prior to 2007-08 what about now? The global industry shrank from a reported $1.89 trillion in Jan 2008 to $1.25 trillion by Dec 2008.

The next issue is demand. Institutional investors such as pension funds, and life insurance companies continue to have rising liabilities for the foreseeable future. They all face the same dilemma of needing non-correlated alpha that can generate some multiple over LIBOR (400-600 basis points) in order to meet anticipated liability exposure. And many cannot and will not raise the exposure to stocks (too volatile) and bonds (low yields). This leaves liquid alternative investments including hedge funds.

But we have already seen that the supply of those mangers is shrinking anyway, which means that a previously tight SS-DD situation will get tighter as demand remains the same or even increases in the years ahead.

This is why the CalPERs seeding model called the Sprout Program makes so much sense. CalPERs already has the in-house skills to pick managers so why not take away that task from HFoFs, do it internally and eventually create hedge fund capacity with an enterprise value that might benefit employees at some later date.

In return for this, the emerging managers still initially under the CalPERs umbrella with CalPERs money to help them build a meaningful track record). As I see it, the goal is not to find the next George Soros, but rather to have a strategy and process that is transparent, disciplined and scalable producing steady, decent returns. And if it fails, presumably the business will be simply closed down with monies pulled.

Asia's institutional investors would be wise to consider such a model. They could collectively reduce search and transaction costs as well as to negotiate the strategy, fee and capacity agenda of many of the future hedge funds. It makes so much sense, that it is amazing why it has not been done before.

Unfortunately, it may yet be a few years before the regions investors realize what opportunity they might have to really embrace hedge fund strategies and talent. For the potential return will require some risk. Mahalo.

2009-03-02T20:55:00.000-08:00

Long Short Equity Suffering Confidence Crisis

"Victorious warriors win first then go to war, while defeated warriors go to war first then seek to win."

Sun-Tsu (circa 400 BC) The Art of War, Strategic Assessments

A vicious cycle is afoot in Asia (and globally), and is threatening the very viability of an ongoing once vibrant, Asian hedge fund industry. The disappearance of market beta and the continuing theme of poor absolute performance carrying over from 2008 into 2009 will trigger more "silent fund shut-downs" which has apparently reached 2-3 managers per day so far this year as investors pull monies and retreat to cash or cash-like equivalents.

The previously most active sponsor of long/short managers in Asia were the fund of hedge funds based in the U.S. and Europe. They used to represent around 35-40% of all allocated monies to hedge funds in Asia. More stable and long term investments by so-called institutions like U.S., Canadian pensions and/or endowments represented a fairly small sliver of total monies allocated (probably around 10-15%).

Much of this never got it allocated as they were the most skeptical about the skill of the region's managers as well as big issues of scalability of their business models.

These investors initially preferred to get exposure to Asia in their portfolios through their allocations to NY and London-based multi-strategy managers like OZ, Ramius, Mariner, Highbridge in the early and mid 2000s. For local expertise in strategies like so-called activism they often went in via local specialists, although this broke down with a number of scandals in Japan in 2006 related to MAC Consulting.

According to data from HSBC Private Banking, YTD performance for the those managers with a Japan Long/Short Equity strategy has been down -1.60%, with the only saving grace a sparse number of multi-strategy Asia shops like Bennelong, Artradis and PMA (Sparx) which have managed to eke out positive returns for the most part.

This is ultimately the only way to foresee any modest revival in investor interest in the region: absolute performance, including capital preservation for the sophisticated investor. The alternative will be that the investor will opt for more cost-effective methods of buying exposure to the region's beta once a bottom has set in; and a bottom will eventually set in.

All manner of service providers are also suffering from the downturn in the hedge fund business and are laying off staff or downsizing accordingly. Things have gotten so bad that the much heralded annual hedge fund conference hosted by GS Tokyo in November may be cancelled. So the short term situation is bleak.

Another manifestation of the current regional malaise is that Singaporean authorities are doing what they can via tax policy to entice some of the Hong Kong business to relocate onto their shores.

It would be wiser to establish a region-wide initiative to encourage the development of a single, region-wide tax and bureaucracy for new or migrant fund firms from the west. They should also look to increase the number of derivative instruments useful to hedge outright equity positions over a number of exchanges; lower margin requirements and generally create an attractive environment for long term participation and investment by global hedge funds looking to escape the inevitable "heavy hand" of legal and taxation that is coming in the U.S. and in Europe.

Now is the golden opportunity for Asian authorities to take a united stand to promote an industry to enhance their capital market development for the coming global market rebound. Asian consumers are almost certainly going to play a key role in that rebound.

And as the regions banks suffer in unison with their western brethren it is important too for cash-rich institutional investors in Asia to team up with hedge funds in order to channel capital into profitable, high growth industrial ventures in their own backyard. They can learn from the experience and skill of hedge funds. Capital needs to be recycled closer to home.

If this is done, it very well may be a new era of growth investing via long/short hedge funds will take off in Asia spuring new strategies and profitable opportunities. The clock is ticking. Mahalo.

2009-02-10T15:14:00.000-08:00

The Incredible Shrinking Asian Hedge Fund Industry

"Everything's got a moral, if only you can find it."

Lewis Carroll, 1865 from Alice in Wonderland

The incredible shrinking Asian hedge fund market saw combined assets drop to around 9% of estimated US$1.2 trillion in global industry assets as at the end of 2008. This is in stark contrast to about 15% of global hedge fund assets that Asia represented in late 2007 (when industry assets topped US$1.87 trillion).

The scary thing is that the Asian hedge fund industry may shrink to under $80 billion by 2010 as the number of hedge fund "corpses" continue to pile up; especially if many long/short equity managers do not learn how to profit from short positions! The possible losses would take the Asian hedge fund industry back to late 2004- early 2005 asset levels.

Latest data from HFR confirmed this longer term negative trend.

It started once international investors started to flee Japanese markets in 2006. Equity Long/Short strategy alpha proved fleeting and illusory, while the so-called activist theme broke down when a number of high profile managers were exposed in legal difficulties. Institutional investors started to sour on Japan, quickly followed by the rest of Asia as the "levered beta factories" collapsed in stunning correlation with the region's equity benchmarks.

Japan was important as it was the first to crack; it also offered the deepest equity market so once that went it was a matter of time for the rest of the region to tumble lock-in-step. Bad sentiment in one geography can easily lead to highly correlated liquidity issues across many geographies.

The hedge fund asset pullback picked up steam from mid-2007. This was due to a drop in Chinese and Indian equity markets that chased away a number of fund of momentum (hedge fund of fund) investors.

Meanwhile, a broader theme of de-leveraging, a reversal of the carry trade and a flight to quality led to a massive pullback in global portfolio investments in so-called "risky" assets in Asia. The bubble had burst and and money pulled back into the most liquid, and "safe" instruments - U.S. Treasuries.

Volumes on regional stock exchanges plummeted and continue to so so as retail investors have also been forced to delever, either directly or indirectly.

All told, this makes Asia a pretty barren trading environment these days for active long/short equity managers. Fundamentals are not shaping out too good as the U.S. and European consumer markets reduce demand for Asian exports while a number of local currencies remain undervalued, with the Chinese Yuan being the obvious miscreant.

Sadly, the short term outlook for the overall industry in Asia remains bleak. Hedge funds will continue to close at an alarming rate; capacity from quality managers will continue to shrink as liquidity remains tight across many asset classes; and, as long as the cost of doing business is remains prohibitive, multi-strategy single managers (the big boys) may stick to opportunistic night desk investing in Asia out of London and New York rather than in expensive Tokyo or Hong Kong outposts.

One man's pain can be another's opportunity. It is time for the region's financial and commodity exchanges as well as their respective monetary authorities to seize this moment to save the industry. Even after accounting for all its high profile "faults" the hedge fund industry plays a positive role in the efficient movement of capital through an economy. They can provide liquidity to markets across various time periods and they can also act to ensure that the management of public companies act in the interest of shareholders - by keeping a vibrant voice on board level policy. Enough of the old style waste and politic-ing.

Greater co-operation and coordination among Asian partners would be an important step to increasing the attractiveness of the region once the industry starts to grow again. This would mean a greater number of high quality derivative instruments to trade, to hedge and speculate in; lower transaction costs and the removal of unnecessary bureaucracy involved for start-up managers; tax breaks to encourage rather than discourage exchange-related activities and trading; and, greater coordination when regulation finally takes shape.

It makes sense to nurture the hedge fund industry as a valuable addition to the region's service industry employment; to retain talent and ultimately to secure a greater number of high value investment opportunities for local institutional investors. The alternative will be Asians relying on Londoners or New Yorkers to continue to manage their trillion dollar pension and insurance assets; an unsavory thought for Asian patriots and Asianophiles like me. Mahalo.

2009-02-05T05:51:00.000-08:00

Japanese Investors "Ran for the Hills" September 2008

"The greatest mistake you can make in life is to be continually fearing that you will make one."

Elbert Hubbard (1856 - 1915)

September 2008 marked a watershed in Japanese investing in hedge funds. Single managers and hedge fund of funds alike report that virtually all categories of investors from insurers, to banks to regional banks and trading companies put in redemptions en masse.

Rather than vilifying all Japanese investors as representing "fast money" the fact is that they were doing what virtually any other institutional investor has been doing around the globe. This author contends that out of an estimated US$30 billion, as much as US$21 billion or roughly 70% came out of hedge fund of fund vehicles, and the bulk of that negatively impacted mainly U.S. based operations.

Who suffers? A large number of so called multi-billion dollar brand-name HFoFs clearly took the biggest hits. The list is likely to include many well-known multi-strategy shops like FRM, GAM, UBS, Ivy, Arden, Optimal, Weston and a few others such as EACM. For many of these managers, Japanese investors typically represented between 10%-25% of total AUM.

It is perhaps the mid-tier FoHF operations, previously with around US$1 billion in AUM that are likely to have suffered the most. For them, the short term impact of the current liquidity crunch has probably put back their AUM growth back 2-3 years. In order for their business model to survive they must now step up marketing in the U.S. market - already damaged by the Madoff fiasco - or else look to merge/roll-up with other middle-market FoHFs. It is the lack of critical mass that might force them into irrelevancy when institutional investors ever come back to investing with them!

The reason for the unanimous fear and departure from hedge fund strategies is well known. For many of these Japanese institutional investors (who operate like well-oiled, slow bureaucracies) senior management meetings all occur around the same time in Tokyo. Typically, they all face the same challenges and tend to move as a group in order to not stand out. This means that when the larger operations make a decision on investments all of the smaller operations will tend to follow.

The question remains, where have these funds gone? The double whammy of investment losses and potential US$ currency losses will no doubt frustrate senior managers back in Tokyo. But, the choices are very slim these days so it is almost sure that some of these funds will eventually be back - probably once the bottom in many markets is already "in". Unfortunately, the reputation of Japanese investors as "hot money investors" may not recover quickly a fact that might worry a number of single hedge fund managers going forward. Mahalo.

2009-01-19T08:12:00.000-08:00

U.S. Treasuries: The Real Economic Pearl Harbor

"Misery is when you heard on the radio that the neighborhood you live in is a slum but you always thought it was home".

Langston Hughes, 1969 "Black Misery"

Falling interest rates globally will have a pervasive influence on asset allocation among fixed income, equities and alternative assets. The tipping point will be whether Asian investors continue to buy or sell U.S. Treasury securities. This, and not the more generalized climate of negative sentiment mentioned by Warren Buffett will be the "Economic Pearl Harbor" of 2009 and beyond.

And initial indications are not encouraging.It is a well known fact that Asian investors dominate holdings of U.S. Treasury securities.

According to U.S. Treasury data, foreign holdings of U.S. Treasuries increased 29% to roughly US$3.1 trillion from Jan to Nov 2008. This was also a rise of 32% Y-o-Y. It indicates that in a global flight to quality trade, U.S. Treasuries continued to be the asset of choice among global investors.

Combined Asian investor holdings of U.S. Treasuries comprised 46% or US$1.4 trillion. This was 6% down from the Nov 2007 level. Of particular note was the massive jump in Chinese holdings by 49% to US$682 billion, with the Taiwan and Tahiland also increasing their holdings by 16% and 25% respectively (albeit from a lower absolute numbers). This is in stark contrast to other Asian investors (Japan, Singapore, Korea and India) whose holdings actually declined.

What does this mean? It means that a special buying program by the Chinese is still intact (for now). It also means that non-Asian central banks and institutional investors have stepped up their holdings too (e.g. U.K. and Caribbean central banks).

It also means that those investors who appear to be tiring of U.S. Treasuries (Japan and Korea) are now probably ripe for alternatives to low-yielding Treasuries. Back in 2003 and 2004 this "opened the door" for massive structured product sales in Asia including sub-prime based CDOs and bonds. The problem now is that a combination of: poor fund of fund returns; the pressure of Basel II regulations; and Madoff-inspired fears of product transparency and liquidity means that many traditional buyers are going to be sitting "paralyzed" by a sense of risk aversion.

In theory "untainted" FoHF brand names should be the winners in the next hedge fund buying cycle. The problem is that many of these product providers have failed their investors with average HFoF performance returning minus 19% in calendar year 2008 and the marketing pitch of diversification also proving a sham.

So which strategies will be the winners in 2009? It certainly looks like Korea and Japan should be prime geographical targets for education programs to help end investors get firmer footholds into managed futures, global macro and certain long-only exposures that might be cost effective. There is little this author sees in terms of HFoF getting signficant market share unless they try to sell managed account HFoF products that might see some favorable traction over the medium term. Mahalo.

2008-12-25T09:51:00.000-08:00

The Hedge Fund of the Last Resort

"She thought that maybe - just maybe - Western Civilization was in a decline because people did not take time to take tea at four o'clock."

E.L. Konigsburg 1996, "The View from Saturday"

December 25, 2008 and the Bank of Japan reportedly decided to take (even more) drastic measures to revive the ailing patient, the Japanese economy. With no monetary policy bullets left in terms of interest rates (with the lending rate at 0.1%), the BoJ has moved from buying JGBs and CP to taking on corporate debt. The backstop has moved from the banking sector, then indirectly to the broader economy in the credit markets to directly boosting the industrial base.

The BoJ is signalling in no uncertain terms that its economy is flatlining, and barring flying over Tokyo Bay and dropping yen on the country there is nothing to stop the inevitable hard landing. Stocks are poised for further downside pressure as expected earnings are revised down.

The BoJ must now be considered the biggest hedge fund in Asia playing across a number of diverse asset classes including currencies, stocks, interest rates and now corporate debt. The irony is that there are no other "natural buyers" other than other Sovereign Hedge Funds (central banks) with an appetite to invest in such close to distressed opportunities. This begs the question that Asian political leaders need to sit down the collective risks and opportunities together- or else- expect a growing threat of social and politicial unrest in the region; and not just from a few displaced farmers, but from unemployed white collar workers!

While central banks have correctly tackled the economic levers individually it is becoming very clear that a more co-ordinated political strategy is now the best option to avoid what looks like a growing risk of cascading national economic disasters leading to global depression. It is noones interest to see this happen.

Other Sovereign Hedge Funds (central banks) in the U.S., U.K., Europe and elsewhere (China) are likely working the phones in the next few weeks. The biggest Sovereign Hedge Funds need to sit down very soon. Mahalo.

2008-12-19T06:53:00.001-08:00

Asia Big Primes Prep for Deep Freeze

"One can survive everything, nowadays, except death, and live down everything except a good reputation."

Oscar Wilde, writer & poet

(1854 - 1900)

As overall trading flow from the US$1.5 trillion hedge fund industry asset goes, so goes associated service provider industries, including prime brokers.

Not too long ago (circa 2006) Asia hedge fund industry assets were an estimated US$150-200 billion or roughly 8-12% of total industry assets. Around a half of these assets came from Asia dedicated strategies which themselves comprised approx. 65-75% long short equity. The remainder came from so-called global managers (multi-strategy or global long/short equity) who, in the good old days, allocated anywhere from 10-40% of their global portfolios to Asia.

This latter group were (and still are) the real movers and shakers in the hedge fund business. They had the most capital to deploy, they were users of multi-currency and multi-market execution platforms (which favored the Big Primes) and they were largest users of stock lending, off balance sheet products, etc.

Pre Sub-Prime Era, global managers expanded their on-the-ground research and trading capabilities in Hong Kong, Singapore, Tokyo and to a lesser extent, Sydney. There were approximately 60 of these Big Funds. Today, many have scaled back laying off staff, allocating little to no money into Asian markets preferring to run night desk activity only, and shuttering any presence in Japan which has felt the biggest contraction on business.

Trading volumes have collapsed. Investors globally have withdrawn from Asia as they have from emerging markets. Not surprisingly, the unexpected drop in transactional activity, IPOs, in addition to the downward trend has changed the near term outlook for Big Primes as well as their competitors.

The pain has impacted all of the players including GS, MS and UBS. They are either laying off staff to skeleton shifts or they are quietly withdrawing altogether placing coverage to other time zones or regions. The next stage will hit Citi, ML, DB and then the other players in the so-called synthetic prime brokerage area including Nomura, Daiwa, Nikko et al.

This is not a short term change of course and talk of a rebound in the regions equity markets may be very premature. As even so called experts like Buffet have come to learn during the last few months, rather than merely another cyclical downturn (lasting 1-2 years) the Big Primes may in fact understand that this is a cyclical change (lasting 3+ years), and with the U.S. dollar falling there is less and less of an appetite to fund an increasingly expensive overseas operation in a stagnant trading environment.

The news will inevitable get a lot worse with many banks getting out of the prime brokerage business altogether in coming months and years. Depressing indeed. Mahalo.

2008-12-13T07:23:00.000-08:00

Japanese Caught Up in Madoff Madness

"There must be more to life than having everthing!"

Maurice Sendak, 1967 from Higglety, Pigglety Pop!

Japanese institutional investors are believed to have suffered badly in one or more of the Madoff products that were marketed to them in recent years. Their exposure is likely to have been US$3-4 billion or maybe even as much as US$7-8 billion if trust banks or consultants had had enough time to direct the hoards of yield hungry Japanese pension funds.

The reality is, most losers are likely to have been investors of firms like Nomura investing proprietary monies, or worse still levering up investments of their HNWIs. In this case the revenue model would have been an up-front load (maybe 2-3% of assets) then a charge for the borrowed funds used to buy into the investment. It is also conceivable that the investor also paid a performance fee too, to Nomura! Clearly, with fees from selling Madoff's "investment" likely to have been as high as 6-7% of assets this was a lucrative "pump and dump" type of scheme.

It is a shame that Japanese individual investors will have to endure a lot of shame in this. Nomura and firms like it should be the ones covered in shame. Ideally, some brave soul should step forward with a Nomura prospectus that shows clearly just how much money Nomura was compensated in the marketing process. All products should have their fees clearly delineated on in investor-friendly adn accessible website. Let there be greater transparency on fees paid!

You can bet that the phone lines from Tokyo to New York and Connecticut were jammed when news hit the wires of the fraud on December 11th!

From an estimated peak of about US$65-70 billion of invested assets in single managers and fund of hedge funds a few years ago Japanese institutional investors have been pulling back from hedge fund products to under a third of that today. After Madoff the contraction is likely speed up.

The reasons were numerous. First, there was the issue of performance. A lot of Asia-regional products had effectively imploded starting with the Japanese focused ones from 2006 onward. The broader Asia-madate managers started to really tank in 2007.

Second, there had been a regulatory consideration (Basel II) that cut sharply the appetite for hedge funds by most financial institutions.

Third, the impact of Subprime Syndrome convinced many investment committees that the marketing pitch of diversification was not reliable or realistic in times of market stress. Aside from hitting hard fixed income arbitrage managers and those that with credit market exposure it also cut demand for many multi-strategy hedge fund of funds that had sold well in the good times on the basis of "name" and "brand". Once performance dipped on these products to below 5% the benefit to Japanese end-investors became questionable, especially in a falling foreign currency denominated product!

Fourth, many Japanese also pulled back investments in toxic structured products when these also fell sharply in value beginnning in the summer of 2007.

The Madoff product was a natural "winner" among weary Japanese investors. It fulfilled many superficial bureaucratic checks that a lot of institutional investor blindly followed: it had a long track record (10+ years); it had the "backing" of established companies who surely had done their own on the ground due diligence (at least visiting the premises once per year); it had an apparently appealing investment story which needs to be really ease to understand or really complex (in this case, complex; it was too big to fail (somehow size always is considered a positive and never a negative); and then, there were those impressive, non-correlated returns that offered an apparent yield of 700-900 bps over LIBOR - attractive to fixed income investors. Some Florida retirees referred to this as their "Madoff bond"!

The Madoff Madness that has erupted should teach Japanese institutional investors a number of lessons. First, hedge fund of fund firms (regardless of name, reputation or size) are no panacea for averting fraud in the industry. In fact, it could be argued that the bigger tyhe firm the more likely the process problems sith catching "problem managers". Second, if performance numbers look good to be true, they often are. Third, if the strategy takes longer than 2 minutes to understand chances are it is riskier than you think!

Fourth, every entity along the hedge fund distribution value chain should be incentivized to take responsbility for short term due diligence as well as longer term performance. Maybe a fixed fee should be imposed with a clawback dependent on various time/performance markers.

Why should a marketer care about the origins of those returns, and how is it that only the end investor loses out in the final analysis? Intermedaries collected their fees and paid their sales teams!

More risk (financial and legal) needs to fall on intermediaries and sales in order to unclog these conflicts of interest and impose responsibility where it belongs. Perhaps, investors should demand that the intermediaries also invest in the same products (and share classes) that they are peddling?

Now, Japanese investors should use the recent Madoff Madness as an opportunity, not to shy from all hedge fund strategies. That does not make sense. Instead, they should stand tall and negotiate responsibility from marketers of these products including deciding not so much how much fees are paid but rather when those fees are paid out. There should be benchmarks and deferred fee agendas to ensure that the interests of the marketers are more closely matched with those of the investors.

Finally, the Japanese investors themselves need to be more professional; they need to hire, retain and pay specialists (real market rates) to ultimately invest directly into hedge fund managers in much the same way that the US endowments and other global allocators are doing. The days of running their financial/investment arms from the HR or General Affairs departments are over. I am sure that this argument has been raised many times in the past. Mahalo.

2008-12-08T17:51:00.000-08:00

Pedigree Be Damned; Give Me Performance

"A casual stroll through the lunatic asylum shows that faith does not prove anything."

Friedrich Nietzsche

'Tis the season to make forecasts. Frankly speaking, I or anyone else for that matter, has no idea what shape the hedge industry will take in coming months let alone years. There have been so many surprises over the last 3 months.

But here goes:

1. Deleveraging. Many equity long short funds had already cut back in 4Q07 through 1Q08 from an average of 3:1 to 5:1 only to ramp up again during the summer as the whole world (and virtually all strategies) chased the same Long Commodities-Short Financials "bubble".

Of course many so-called quant-driven funds employed double that amount in leverage terms and had already taken various hits (see Goldman's Global Alpha, RIEF and various AQR funds).

In the months and years ahead, "primes" will not be actively bidding against each other to throw free money to the big hedge funds in order to capture their flow. In this new environment, the 250-300 bps execution cost advantage that Big Funds ( AUM over US$6 billion) had will vanish! This will hit the performance of many famous names such as Citadel.

On the single manager level much of the deleraging is likely to be over by Jan/Feb 2009 as the situation with regards to investor redemptions should look clearer. Look for single managers to start to employ more capital very soon into the new year.

Another often missed point when it comes to deleveraging is the fact that maybe up to 20-25% of HFoF total assets were in products that were effectively levered at the portfolio level. The underlying assets were typically relative value strategies and "low vol" in normal trading conditions.

Bye-bye normal trading conditions. These funds which were aggressively marketed through Swiss private banks and many European FoHFs have cratered. Simply put, a minus 25% return in the unlevered fund now turned into a minus 50-75% loss (depending if the fund was levered 2X or 3X). Naturally, these investors have run for cover and the brand damage to the remaining FoHF firms has been crippling. Many HFoFs may go under as a result. I expect as many as 75% might disappear/merge in 2009.

The reality is that other non-hedge fund players have employed significantly more leverage including investment banks (30-50X) as well as some of the prop trading operations of the SWFs.

2. Redemptions. The media guessing-game as to how much the industry is going to lose has been greatly exaggerated. Listening to so-called talking heads making guesstimates is about as analytical as a monkey throwing darts at a board!

The reality is that October and November saw 2 of the biggest monthly redemptions by investors from mutual funds not hedge funds. The sums amounted to close to US$1 trillion and US$800 billion respectively on a global basis. That compares with the hedge fund industry total assets of just under US$2 trillion. You tell me which players have experienced the more shocking outflows? Look at the press today and the Fidelities of the world are in retrenchment mode due to the investor outflows. This is the real issue. Retirees have been voting with their wallets out of these vehicles, heading into short term Treasuries and CDs. Why have significant exposure in equities and bonds if you cannot hedge?

Among single hedge fund managers I have looked at, not all managers have 3 month redemptions or 90 day notice periods, so that there could never be a situation where a tsunami of redemptions would be unleashed on the financial and commodity markets. And yet the press keeps on harping on it as if it were a fact. Strange. Strange too, is the fact that many institutional investors like pension plans and endowments actually have long-term investment horizons and this means that they too will tend to flip unprofitable with profitable strategies and managers in their portfolio mix.

It is more likely to be the panic sellers who need cash here and now who have sold and will continue to do so (often hiding in short term U.S. Treasuries). I estimate that US$250-US$300 billion in AUM will redeem from hedge fund strategies especially from long/short equity, event driven, convertible arbtirage and fixed income arbitrage.

In the new hedge fund world, if you as a manager cannot prove that you are not in crowded trades and do not have a hedge then it will be hard to raise capital. The days of relying on pedigree alone will be over. Investors want performance pure and simple. We will enter into a "Show Me The Money" world of investor expectations.

On a not unrelated note, expect redemptions from HFoF to really take off. This is where I think the real potential issues will lie with investors. Now that the bulk of these bastions have not offered diversification or poor performance institutional investors may take a very large bite out of those firms that have really bombed out in 2008.

HFoFs may endure fee reduction in return for short-term investor loyalty. This is really here the shocking impact of redemption flight that is taking place right now. Big established FoHFs will go under or be forced to merge. They will look to cut costs and so outsource increasing portions of the business model in order to specialize on the portfolio construction aspect of the operations.

One way that FoHFs are fighting back is by setting up the same model operated through SMAs. Time will tell whether this model will be flexible enough to encompass a broad enough range of hedge fund strategies to be considered a truley scalable business model (i.e. taking in several billion dollars).

While the proponents will point to the likes of Lyxor as having a sustainable business model, many single managers do not like to have these large behemoths moving large % of assets in and then out of their coffers. Size and reliance on size can kill!

In short I expect about 50% of the HFoFs to "die". The lone growth area will be seeding and incubation where the capital provider typically takes some of the economics if not the equity of the General Partnership. Remember too that it will take capacity in the future to feed the impending supply-demand imbalance in the industry.

3. Attrition. In normal times, Tremont had calculated average attrition rates since 1994 at 8% for single managers and 12% for FoHFs. Depending on which region you are talking about (Asia will almost certainly be higher) look for 25% for single managers and 40% for HFoFs. there will be many zombie hedge funds in coming months and years as management fails to execute the changes necessary to turn their businesses around to attract assets.

In any case, it might simply be easier to shut the firm down and start again minus the legacy of losses and the weight of being way under the high water-mark. Unlike previous times, I am not too sure that institutional investors will be as forgiving the next time around to these managers.

4. Performance. Why is so little debate raging about performance? In my estimation barring the blip up in 2007 performance compression is a fact of life for the industry moving forward. I believe that equity markets will rally within a range in the next 12-24 months and some of the upticks will be rapid and sharp in percentage terms. But let us to confuse beta with alpha.

Overall performance will probably be subdued. Rememebr that the risk free rate is falling again and especially with significantly lower leverage this mean that average FoHF returns will fall back to 4-7% annually and not the 8-12% that was marketed by many a few years ago.

Of note too, the days when the top quartile Big Funds enjoyed a 660 bps performance advantage over average hedge funds from 2002-2007 may be over too due to almost inevitable restrictions that might be placed on them by global financial authorities, such as in the case of shorting stocks, or in cases of activism.

Performance is the most important issus facing managers in the months and years ahead. For those boutique firms that produce alpha and that can hedge, I predict that they will command higher fees. The fee gaps between these managers and those that offer low performance, non-correlated returns will widen. They are starting to anyway. I do not think that the 2-20% model is dead. In fact, I think it will should thrive and investors would be unwise to give the wrong signals to the those managers that in this environment have produced alpha.

Shouldn't these managers with proven skill be rewarded if they can produce outsided alpha? It might be worth thinking about, if we all want to enjoy any pensions in the coming years. Now is not the time to kill the goose that lays the golden egg. Mahalo.

2008-12-06T12:27:00.000-08:00

The Golden Age of Hedge Funds in Asia is Officially Over

"Sometimes it is harder to deprive oneself of a pain than a pleasure."

F. Scott Fitgerald
Novelist, from Tender is the Night (1896-1940)

As 2008 draws to a close the case for investing in Asia dedicated hedge funds appears to be falling like the collective performance of the industry.

It seems like a million years ago when all of the fundamental arguments in favor of Asia were trumpted by the media, academics and managers-alike. Asia was the place of fast growth companies; a growing, middle class consumer; a place where savings still outstripped personal consumption; and, where hedge fund managers could trawl for more abundant alpha.

According to data as of late November 2008, a sample of diversified equity hedge funds specializing in Asia followed by HSBC Private Bank, produced an average year-to-date return of minus 24.04%. The worst performer at minus 94.47% was 788 China Fund Ltd run by Jacques Mechelany and Michel Artaud. The best performer was Arnott opportunities Fund at 4.14% run by Kenneth Arnott. Aside from the stunningly poor performance one cannot help but notice the fact that assets have declined substantially across this and other single managers.

Looking at diversified equity hedge funds specializing in Japan, HSBC produced an average year-to-date return of minus 13.16%. This is one of the few times when having exposure to Japan rather than the rest of the world might actually have been "good". The worst performer was GAM Japan Equity Hedge Fund run by Lesley Kaye at minus 46.00%. The best performer was Gary Rosenfeld's Rosehill Japan Fund A at 3.36% through the end of October 2008.

The problem with falling asset base is that it inevitably pressures managers into cutting overhead which means losing staff and rolling up strategies or even funds. It also leads to price pressure as managers do what he/she can to keep clients or find new ones (if they can!). This, in turn, means that there is less liquidity across Asian markets. So much for talk of decoupling, at least for now!

The hedge fund model in Asia (and elsewhere for that matter) is broken. It will take time, education and "proof in the pudding performance" to bring back investors into these strategies. This is not just an ailment afflicting simply hedge funds but long-only mutuals and more critically the hedge fund of fund model as well. If anything, this recent blight that has impacted global equity markets has highlighted the importance of the "hedge" in the term hedge fund and either your fund can do so or it can't.

In some ways we may see a return to the original hedge fund trading style initially launched way back in 1949 which was essentially an equity market neutral kind of strategy. The days of investors backing levered-beta factories may be over. I for one will not back someone who offered this model to me, cloaked it in a 2-and-20 fee schedule and still did not cushion my downside risk. It simply does not add up.

That said, for those looking for signs that a turnaround in the markets may be coming it might be wise to focus on the region's banking sector. When these "pop", the chances are that the markets will rebound sharply. The question for investors might be to get access to such beta through a cheap ETF rather than through an expensive hedge fund format. But even in a recessionary cycle there will likely be more than one bear market rally. Take care out there. Mahalo.

2008-12-04T17:20:00.000-08:00

Trading Companies Retreat From Hedge Fund Business

"He who is not courageous enough to take risks will accomplish nothing in life."

Muhammed Ali, former boxing world champion (b. 1942)

To date, the 4-5 biggest of Japan's trading companies have been treating from the hedge fund business. In their hey day, Japanese trading companies managed either directly or indirectly approximately US$8-10 billion of hedge fund product and brought it over to Japanese investors. Many of the these companies also invested (and some still do) on a proprietary basis in hedge fund strategies.

But the short term performance losses and redemption pressures from Japan-bsed investors have forced senior management in many of these firms to make an about face - in many cases to dump the same business model that they had built up since 2003/04.

By some accounts, Japanese institutional investors have put in 30%-40% redemptions with FoHF and single managers in 2008. The sudden and shocking appearance of "gates" and the move by some firms to imposee additional lock-ups sent many of them out, and potentially for good. At the very least it kepy up European and U.S. based operations to handle the Tokyo requests for clarity of what is going on in hedge fund land!

The fact of the matter is that Japanese institutional investors and many of their disrtributors are rotational investors. That means that they follow the "hot hand" in terms of strategy and manager. As investors you do not get rewarded for making good investment decisions, but you od get punished (by being sent to some remote regional posting) for bad investment decisions which means that the incentive system is also screwed up.

One such "victim", a prominent Japanese trading company has effectively shut down its business seeding 6-8 managers out of New York. In the old days they would try to find and negotiate equity on a one-for-one basis in return for US$20 million investment in the fund and in the firm (for operational fixed costs). The Japanese partner also marketed the returns to Japanese investors through its brokerage network back in Japan.

A similar pressure to streamline and/or retreat is now going on with other larger trading companies. But not all are moving back at the same pace. Mitsubishi is an exception. It has recently bought a stake in a European based finxed income arbitrage manager utilizing a relative value strategy. At the same time it is believed to have pulled somewhere in the order to US$200 MM from an existing investment that it had made with the CT seeder called Weston Capital.

Sumitomo has been a seeding manager with US$25-30 Million stakes and is apparently now culling those that "are not working" while focusing on those that are working. This means they are focusing on the positive performers (if indeed they have any of them).

Marubeni has not been doing too much although they were late to the business initially and when they did get involved they were CDO distributors in Japan. Of course that model has gone up in smoke!

The critical issue remains: what will Japanese institutional investors like pensions and some financial institutions do in the months and years ahead with equity markets likely to remain range-bound, the currency remaining strong and bond yields remaining very low? Surely they will have to find "profitable" absolute return product somehow? And where will that supply come from? Mahalo.

2008-11-25T14:27:00.000-08:00

The Crash of the Titans

"The war of the giants has ended; the quarrels of the pigmies have begun."

Sir Winston Churchill (1874-1965)
U.K. Prime Minister

One clear comment that can be made in the light of the extraordinary events that have unfolded since the summer of 2007 is that in hedge fund world Big is Not Beautiful - anymore!

Today, it seems that the larger the hedge fund the more susceptible it has been to redemption flight risk. This is what can be expected in a world in which liquidity mismatches were the norm and where beta was produced in abundance but in a grossly correlated manner.

Those larger funds managed to generate an estimated additional 260 bps of extra performance per year from 2000-2006 versus the average hedge fund as defined by the Credit Suisse/Tremont Hedge Fund Index. In this case, a big fund had assets under management of over US$6 billion as of 2000. In fact, the top quartile performers actually produced over 650 bps more per year in the elusive "alpha" per year versus their hedge fund brethren.

It was a time of plenty. The biggest institutional investors recognized it and the managers themselves saw it. The party roared on, and as it did, the prime brokers also enjoyed the gains. In fact, they helped keep the spigot of leverage, stock loans and deal flow going to the funds very often reducing the execution and cost of capital costs for these big players by as much as 250-300 bps per year! Now that is what I call alpha! Many of these fund managers fell into the trap of growth for growth sake lured by ever attractive management fees under the mantra of diversification. Even the investors bought into this marketing pitch.

The fact is that ever manager knows that the best time to invest in a hedge fund is when the manager is in his "emerging" phase. This is the time he is really focused on alpha, getting the highest performance and keeping operational costs lean. He/she is hungry but typically too small or not institutional enough for pension plan investors who have US$10 million slugs to go followed by US$20-50 million slugs every six months.

Size can help the manager operate anonymously, not leaving a trading trail for brokers to front-run or other managers to poach off of! This was the sad turn of events that tripped up so many of the big multistrategy funds in the Fall of 2008 when an incredible number of them were in the same "short financials-long commodity" trade. It collapsed miserably and exposed the hedge fund industry for all its faults.

Today, investors in Asia and elsewhere are disillusioned with hedge fund industry performance, risk management and all of the other institutional-quality benchmarks which appeared to break down. That there will be a cleaning out of the single manager field is always an issue. In normal times Asian managers suffer a 8%-12% mortality rate, but in 2008 this figure will likely hit 35%-50%. The damage to hedge fund of funds may be even greater. But as the words of Martin Charnin in a famous musical go: " The sun will come up tomorrow"!

We have all learned that big is no longer beautiful. Investors appear to recognize this and are punishing the share prices of publicly traded hedge fund shops like Sparx. Mahalo!

2008-09-29T08:56:00.000-07:00

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.

2008-09-18T05:17:00.000-07:00

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.

2008-09-17T16:43:00.000-07:00

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!

2008-09-08T06:02:00.000-07:00

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.

2008-08-15T07:58:00.000-07:00

Japan's Zombie Hedge Funds

"On the plus side, death is one of the few things that can be done just as easily lying down."

Woody Allen
Film Actor & Director (1935 - )

Like a bout of the Avian Flu, more and more Japanese specialist hedge funds (many of them long/short equity) appear to be in a death spiral. Not many years ago there were over 200 hedge funds in New York, London, Singapore, Hong Kong, S.A.R. and Sydney commanding combined assets in the range of US$20-25 billion focusing almost exclusively on the Land of the Rising Sun. Today, that number of funds is closer to 80-100 and the AUM managed is closer to US$7-9 BLN. Yikes!

"Zombie hedge funds", in this case are Japanese specific funds/firms which have undergone a steady and swift loss of AUM: initially from foreign FoHF investors, U.S. and Canadian pension plans and are now "hanging on" for dear life with a few million here and there from local Japanese investors; and that lifeline is soon to end.

Many prime brokers already have their own list of zombie managers and are not likely to steer some of their well-heeled investors in their direction and for obvious reasons.

Sad to say, many investors have abandoned the steady stream of double digit losses and have been fed up with the usual excuses - unexpected volatility, lack of liquidity, poor sentiment, program selling by institutions, lack of IPO activity, economic recession (or the best one yet), the Nikkei 225 is down so we can't produce any alpha!

In fairness, even Asia's "best" hedge fund producer, John Zwanstraa, has had a tough June and July in terms of performance. And one worry might be that Japan's zombie hedge fund phenom might spread to other locations (like China). So far, that hasn't really happened even though emerging markets have certainly moved down the global investor priority list although the Beijing Olympics might prompt a fresh inflow of investor interest in the short run.

But, based upon the performance number through July from hedge funds covered by HSBC Private Bank, the following are candidates for this author's Zombie hedge fund status given their negative YTD return and low AUM figures: Blue Sky (Michael Hill); GAM Equity Hedge Fund (Lesley Kaye); Henderson Japan Abs Return Fund (William Garnett & Jeremy Hall); Melchoir Japan (Ken Nishizawa); Myojo Japan Long Short Fund (Makoto Kikuchi); Odey Japan & General Inc. US$ (Alex Griffith); Platinum Japan Fund (Kerr Nelson); WF Japan Fund Ltd A/1 (Peter Ferry).

Each of these funds and possibly up to an additional 10-15 more are what I would call "zombie hedge funds" - unproductive and unloved by the global investment community with the clock definitely ticking in terms of being a long term viable business.

As we head into the second half of the 2008 calendar year a few of these may very well shut down for good, ending a sad chapter in hedge fund development in Japan and Asia. Mahalo.

2008-08-15T05:55:00.000-07:00

Institutional Investors Expected to Buy More Fund Product, in 12-24 months

"The war of the giants has ended; the quarrels of the pigmies have begun"

Sir Winston Churchill
U.K. Prime Minister (1874 - 1965)

Reportedly pointed comments from a number of U.S. public pension plans about their willingness to significantly step up alternative investments is worth noting. When the NY Common Retirement Fund (US$153 billion in AUM), South Carolina Retirement System (US$29 billion), Teachers Retirement System of Texas (US$106 billion in AUM), New Jersey (US$77.7 billion in AUM) and others are all expected to significantly step up allocations to alternatives then something BIG is going down.

The reason for all the talk of institutions "going alternative" is the plain fact that passive investment in plain vanilla equities and fixed income have all gone down the tubes in the first half of 2008. For example, when the MSCI World TR USD Index loses minus 10.35% and the Lehman Global Bond Aggregate up 3.53% then a certain amount of worry sets in. The same type of concern is now logically facing many large Asian institutional investors; specifically, Japanese pension plans and life (and non-life) insurance companies.

As we have previously estimated, the total of Japanese institutional investments in hedge funds (single managers and FoHFs) is likely to be be somewhere just under US$60 billion which was the high-point a couple of years ago - or until financial institutions started to cut back due to Basel II considerations.

As the average Japanese institutional investor is currently allocating anywhere from 6-12% of total AUM in hedge funds one might expect recent poor performance in traditional long-only product to lead many of these investors to re-up their allocations to hedge funds, private equity, real estate and commodities.

It is conceivable that hedge fund allocations might increase to 15-25% of the average Japanese institutional investor portfolio over hte medium term.

Now is the right time to market to these institutions especially if alpha producers have non-correlated positive return funds to offer. And in the current environment that might be easier said than done.

Expect trust banks, life insurers and non-lifers to listen intently, only this year, they might actually make allocations. Their fixed liabilities driven by increasing numbers of retirees depends on it! Mahalo.

2008-07-28T04:29:00.000-07:00

Correlation Dilemma To Hamper Brains

"Drive thy business or it will drive thee"

Benjamin Franklin (1706 - 1790)

According to reports, Mitsubishi Asset Brains Co., the investment advisory arm of one of the largest city center banks in Japan is launching a fund of hedge funds. This time around the focus is on non-correlated returns. Now there is a novelty! This is like saying for the vast majority of the FoHF product range they are not currently focused on that as a starting point of their very existence. Odd indeed.

The fact of the matter is, finding managers with returns uncorrelated either to equities or fixed income is becoming more and more difficult. A recent diagram in a Lipper hedge fund report showed clearly the dilemma facing Nishi-san and his multi-billion dollar plans: correlations over the bulk of 6-month, 12-month and 36-month time horizons across 13 of the Credit Suisse/Tremont hedge fund sub-strategies point to GROWING correlation against the MSCI World Index. This is to be expected in time of market stress.

Only 4 of them showed solid non-correlation over the 6-month period. These were: Dedicated Short Bias, Global Macro, Equity Market Neutral and Managed futures. But over the longer 36-month time period even 3 of these "exceptions" proved to be positively correlated.

The bulk of sub-strategies exhibit a correlation with the MSCI World Index of between 0.6 to 0.85 which are high readings.

Which leads to the second dilemma, which is that if you are pretty much restricted to directional strategies are you not simply just offering a niche fund of funds with capacity limitations? That is what it sounds like to me.

Would it not be simplier and more cost effective to simply hedge against the MSCI World in order to achieve ones goal of non-correlation, and, at a sigificantly reduced cost?

Moreover, during the last 18-months there have been factors such as liquidity and deleveraging that have contributed to the apparent fall in correlation in some strategies such as with Equity Market Neutral - rather than being some fundamental shift in assets.

All told then, perhaps this "new" product is better described as yet another niche FoHF product designed to soak up institutional assets in Japan - something that is becoming increasingly difficult given the poor performance of a vast majority of products. You will certainly need sharp brains to sort this puzzle out. Mahalo.

2008-07-09T12:03:00.000-07:00

India: A Middle Class of 230 Million Investors

"I believe in equality for everyone, except for reporters and photographers."

Mahatma Gandhi (1869- 1948)

Despite the double-digit negative performance of the Bombay Sensex so far in 2008, the growing wealth among Indians has spawned the country's first multi-family office. A former MD of industrial giant (and out-sourcing specialist), Infosys Technologies, as reported in The Times of India, established Ethos Capital Advisors to manage the wealth and trusts of a number of families.

The traditional method of wealth management had fallen upon individual families in collusion with their accountants with surplus funds parked in a separate company or trust structure. the current development is moving towards a more formal system of wealth management that has been copied in the U.S. and Europe over a number of generations already.

It is worth noting that the family offices have typically been unafraid to invest in alternatives including hedge funds, private equity and real estate. This development suggests that there may steady and increasing demand years for strategies and acorss various asset classes that diversify out of the Indian Rupee.

This might be a not-inconsequential sum given that it is generally known that there is a growing middle class in India numbering over 230 million people and that there are more dollar millionaries in India than there are in the U.S.

And, as if to drive home my point a recent GS report on global middle classes postulates that the incredible transfer of these new buyers into the global ecnomy will exert a new force both politically and in terms of what good and services are produced. Think about it. If only 1% of India's 230 million "middle classes" actually have disposable income in excess of US$10 million then that means there are 2.3 million potential hedge fund buyers about to enter the market!Opportunity knocks. Mahalo.

2008-06-12T05:54:00.000-07:00

MITI Criticism of Japan Poison Pills Starts

"What is food to one, to others is bitter poison."

Lucretius, (96 BC - 55 BC)
Philosopher

Hooray for Japanese officialdom! According to a recent MITI panel conclusion emanting from Japan, corporate managers should review the use of anti-takeover provisions and consider whether they harm shareholders' interests.

A MITI panel released a report as part of national efforts to shore up its reputation on corporate governance and receptiveness to international investors.

The report follows increased criticism in recent months from some non-Japanese investors (like The Children's Fund) over anti-takeover practices such as poison pills and cross-shareholding arrangements. These are anathema to shareholder value and corporate governance.

This follows on the heals of a recent MITI decision that ordered The Children's Investment Master Fund to abandon a plan to double its stake in Japanese electricity-grid company Electric Power Development Co., known as J-Power, to nearly 20%. MITI said then that J-Power was of strategic interest to Japan. Strange that the same complaint was used by the Russian Government when BP was denied access to a stake in oil reserves in that country!

The ministry panel's report Wednesday warned takeover defenses shouldn't be adopted simply to protect corporate managers' own interests. Managers should consider putting takeover proposals to shareholders to allow investors to assess the merits of approaches themselves. Let's hope that shareholders now have the gumption to actually do something that is in theiur interests and not in the interests of "management stooges". Maybe Japan activism does have a role after all. Mahalo.

2008-06-09T15:25:00.000-07:00

Long-Biased Equity Strategies Still Underwater in Asia

"Remember this - that there is a proper dignity and proportion to be observed in the performance of every act of life."

Marcus Aurelius Antonius (121 AD - 180 AD)
Philosopher

Investors in many of the Asian region's long-biased equity strategies have suffered considerable performance heartburn according to latest YTD numbers. This fact, coupled with net outflows of assets and the "silent" closing of funds (Odey Japan, one of Rubato's and a whole host of others) is putting a lot of pressure in an industry that not too long ago was one of the highest growing in the global hedge fund industry. Not anymore.

The performance destruction among Asia funds and Japan funds has been equally bad. For example, according to the Banque Syz data from their Hedge Fund Advisory group for the period ending May 29 2008 (#22), 21 out of 27 funds of the Asia Equity variety carried negative YTD returns. The average of those negative returns was minus 8.84% while the positive funds posted 4.06% - which is not likely to pay for fees and associated costs. The average fund performance was minus 2.39%.

The best performer is Bill Hwang's Tiger Asia Overseas fund which returned 13.39%. The worst performer (not by far) is Martin Hughes' Tosca Asia Fund which posted minus 17.18%.

For Equity Japan, the average equal-weighted performance of the 44 funds was minus 2.48%. A total of 30 funds continue to post negative YTD retuns with the worst being Ken Nishizawa's Melchoir Japan Fund $ at minus 21.55%. This continues a pattern of double digit losses that has been seen over the last 2 years and it is almost certainly leading to serious assets depletion. On the positive side, the best performer on a YTD basis in the Banque Syz Japan Equity universe at 12.81% was the Martin Currie ARF - Japan Fund - VAMI managed by Donaldson, Temperley and Troup.

A worrying trend has been the fact that it seems very obvious that many of these funds are not in fact "hedged" their returns tend to mirror the direction and scale of returns offered by passive ETFs or traditional indices. It does not take an institutional investor with a degree in quant finance from MIT to work this out.

For this reason expect the new trend of managers to favor passive, low cost beta-vehicles to continue. Further, there may be a move towards more illiquid strategies including multi-strategy for above above performance in the near future. That is where alpha will be more easily produced which may be non-correlated (at least for the majority of the time). There is also an opportunity for 130-30 funds and equity market neutral strategies that can demonstrate an ability to produce alpha.

The days of the US$1 billion single manager strictly trawling Asia may be over unless of course the vehicle is large enough to be able to tackle large buyouts, private equity and real estate deals. I predict the emergence soon of the multi-strategy alternative investment shop. In the meantime, look for more "silent closings", primes getting squeezed and squeezing smaller managers and the industry to undergo major changes. Mahalo.

2008-06-06T17:07:00.000-07:00

Japanese Corporates Reveal Attitudes to Hostile Acquisitions

"A bank is a place that will lend you money if you can prove that you don't need it."

Bob Hope (1903 - 2003)
Actor

In the midst of a contentious debate between a leading hedge fund activist and J-Power the electricity utility, a recent survey from a leading Japanese brokerage sheds new light on what Japan Inc. thinks about M&A.

The survey was conducted in May 2007 and polled 1,464 major listed companies of which 205 responded to the 28 questions.

There were certainly a lot of answers that support the view that Japanese management views any criticism, much less, from foreign activists with suspicion and resentment. Not surprisingly, the case that many activists make is readily dismissed by boards of directors and management that feels "threatened".

A total 59% of respondents consider that perceptions of an increasing number of hostile acquisitions are unfavorable and negative (but for whom?) while 62% were negative with regards to the role of investment funds (or hedge funds) although this was pretty close to the level of suspicion that is leveled at other corporations that alos engage in the practice!

Apparently, the increasing trend is not really permeating down to the corporate boardroom as a combined total of 84% of respondents saw little/no threat to date from hostile acquisitions. This supports the view that many large multi-strategy funds (like Ramius) based in Tokyo have been saying about the climate for some time - that there really is nothing really going on other than a few high profile M&A cases, and that Japan Inc. still is not open to ANY discussion when it comes to shareholder value.

It seems that in terms of defensive tactics Japanese coporates prefer to rely on the introduction of a "poison pill", to strengthen cross-shareholdings, and to increase long-term shareholders who approve the current management. In terms of the type of "poison pill" a majority tend to favor the pre-warning type and they execute this typically through an ordinary resolution at a shareholder's meeting, and in some cases this may mean a change in the Articles of Incorporation of the firm.

Interestingly, for those firms that do take up an aggressive defensive tactic and have introduced a poison pill, there is often a special committee with independent members voted on the board. These members are typically between 3-4 with attributes at the sub-committee level of outside auditors and other outsiders. Other interesting facts include that these people rarely meet, are not considered "active". Many companies often introduce a sunset provision of 2-3 years at board meetings.

Regretably, the legal system, the media and the authorities are to blame for this apparent paralysis. A good dose of M&A activity is needed to bring corporate Japan kicking and screaming into the future. It is needed as one component to bring "life" back into the unlisted and listed company markets in Japan. Mahalo.

2008-05-30T05:19:00.000-07:00

In Asia, like in the Rest of the World, Hedge Fund Performance Matters

"Maturity is a bitter disappointment for which no remedy exists, unless laughter can be said to remedy anything."

Kurt Vonnegut, 1922-2007
Author

The number of global hedge fund managers will likely stagnate this year as smaller firms struggle to raise assets. This should come as no surprise. And guess what? The challenges facing firms will also impact Asia.

According to Eurekahedge, the database and third party-marketer, there were 628 Asia-focused firms managing 1,170 hedge funds in April 2008 versus 183 firms in 2000.

This author "guesstimates" that the combined AUM of hedge funds is still around US$200 billion although this is believed to be down 10-15% from 18 months ago.

It is worth remembering that the global diversification of the big, often-closed long/short equity, multi-strategy or relative value players that typically weigh in with the biggest assets in the regional stock markets.

As in the U.S. and in Europe (why should Asia be no different?) institutional investors, having suffered a performance battering ram in the first quarter of 2008, are now fishing for those big, behemoth single managers and fund of hedge funds that are most likely to "survive" and satisfy their institutional infrastructure demands.

While new fund launches are down in Asia, closures are almost certainly up (attrition rates running at 15% per year vs. an average of 8.5% globally from 2000-2006) - especially in Japan.

As long as performance continues to disappoint the trend is likely to continue. Eurekahedge data suggested that Asian hedge funds were on average minus 5.9% year to date versus minus 1.1% year to date for their global fund index.

The reality is that getting to the US$250 million mark for a start-up manager is probably necessary in order to garner institutional assets (from pension plans, the largest fund of funds, endowments and the like).

Performance, or the lack thereof, still dominates the decision by insitutional investors in their "invest or don't invest" decision in Asia. Frankly,when returns are sub-10% gross (which certainly was not the case in 1Q2008), people complain about 2-20 fees and rightly so. In any region of the world, it is the simple math which is drawing attention to the whole business model of hedge funds and forcing investment committees to ask: "are these strategies really worth it?"

For example, back to the 10% gross returns 10-2=8 8-1.6 equals 6.4%. And if the returns are up at 15% gross then the return to the investor shifts to 10.4% (15% gross - 2% = 13, 13-2.6 is 10.4%). So if managers can't generate at least 15% then the net of 10% is troubling, especially if the broad indices are up 8-12% in that time frame. Remember too that long managers have a better tax efficiency.

Maybe this is the reason that some of the money that might be fleeing hedge funds is flowing back into 130-30 products, index enhanced strategies and other low cost alpha generating products. For beta, there may be more cost effective ways to get exposure in the region.

So called "experts" tend to forget a simple practical fact that performance expectations for Asian investments tend to be higher than in other markets due to the reality of higher perceived risk facotrs. So even a 15% bogey (performance target) might simply not cut it for many types of investors given that the overall market volatility is so high.

On the bright side, there appear to be good opportunities in Asia investing in distressed assets, asset-backed lending to mid- and small companies, in M&A, in investor activist ideas, in infrastructure project financing and in market neutral strategies. And yes, many of these strategies might involve tying up capital in illiquid markets or strategies. But isn't that the M.O. of the big, largely successful managers in the rest of the world? You will need to go more illiquid and accept a longer lock-up in order to participate in the perceived 20%+ returns that exist in Asia.

All this assumes that the authorities do their collective part and not impose direct or indirect restrictions on hedge funds and other financial entrepreneurs. Mahalo!

2008-05-19T06:06:00.000-07:00

Deciphering Global Hedge Fund Statistics

"The secret of staying young is to live honestly, eat slowly and to lie about your age."

Lucille Ball
Actress (1911-1989)

One of the biggest problems in the hedge fund space is data mining. Aside from the crazy assumption that historical data and returns can extrapolate into the future, many users of commerically available databases somehow think that they have discovered or uncovered rare secrets from within a mystical hedge fund black box. This is hubris.

Take the latest example unleashed on the world by Pertrac. There are a vast litany of negative concerns related to hedge fund data including self-selection bias, sample selection bias, survivorship bias , backfill bias, and infrequent pricing bias.

Added to these, there are additional very serious classification issues that exist when you have two or more totally different databases with their own labels and you try to fit them together. For instance, where does one put an ABS fund in the HFR database, MSCI database and the Lipper TASS Hedge Fund Database? Is it a fixed income arbitrage fund, a multi-strategy fund or a relative value fund? No-one really knows. But where you put it will certainly impact the data results of risk and return across a number of strategies.

Perhaps the biggest "problem" leveled at databases is that of self-selection bias. While critics point out that only the better funds tend to provide their data to the outside world a reverse argument (and equally legitimate one) is that the best funds do not report to the same databases and so perhaps there are under-reporting biases that should be considered.

Of course, you don't hear much about these funds whenever a news releases comes out!

Which brings me to the case in point. Pertrac, recently analyzed hedge fund data reported to a large number of databases which are consolidated in their analytics package. They claimed that hedge funds report their best performance in their first 2 years. They claimed that a track record of less than two years produced, on average, 11.7% while performers over 2 years produced 10.2% return - a difference of 1.5% on average annual performance.

What the study did not point out was quite a lot. Namely what about the risk-adjusted performance? What about the fact that the smaller funds probably had significantly lower AUM and so in simple numerical terms starting from a lower base their performance was over emphasized. And what about all those closed big funds out there which are not in the databases? The Kensington Global and Medallian Funds of the world...what happens if you include this data into the results?

In fact in an alternative view of the data world a recent comment at a forum in Hawai'i by a academic pointed out just how much of a gap in our understanding of these big closed funds might be out there.

In the presentation covering 20 of these large single manager funds with AUM of over US$6.4 billion there was a definitive performance advantage favoring larger funds. How much? Apparently, an average of over 2.50% per year and for the top performing single managers (top quartile) the number was a staggering 6.00% outperformance per year since 2003!

The reference point for these returns was over the Credit Suisse-Tremont Hedge Fund broad hedge fund index, and, if true, it points to a very significant advantage of big over medium and presumably small too.

Data mining too? Could be. But it might at least shed some light on why the biggest institutional investors in the world are willing to pay higher fees and take on longer lock-ups in order to get access to such funds. It might also explain once and for all the key competitive advantage of the best performing fund of hedge funds - real estate- or simply being invested in the right funds.

And if one wants to focus on age then the average age of those best performing big funds was 13 years. So maybe as Lucille Ball and Marlene Dietrich would have said size and experience matters too. Mahalo.

2008-05-16T06:30:00.000-07:00

Owning Up to Sub-Prime Losses May Spur Rally in Bank Stocks

"The power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas."

John Maynard Keynes
Economist (1936-1973)

Is the worst over for Japanese banks? Recent data out of Japan suggests that may be the case. According to data for the financial year ending March 31, 2008 Mizuho Financial Group reported losses in the U.S. subprime sector of US$6.14 billion (Yen 645 billion). It also reported an 80% increase in profits to US$5.31 billion (Yen 560 billion) including a share buyback program amounting to US$1.42 billion. Mizuho had been one of the worst afflicted by the Subprime Syndrome so the latest news is welcome.

Other banks may also be signalling that tough times may be over. Sumitomo Bank, one of the biggest, reported that net profits rose over 20% to US$95 million due to a fall incredit costs while Aozora Bank forecast that its profit would increase to US$42 million as it recovers too from subprime exposure.

Implications? First, expect a short term rally in the equity markets. Aside from the fact that subprime had been weighing down balance sheet growth recent growth numbers out of Japan point to a still bouyant economy, helped in large part by export-driven business out of the BRICs. Second, with greater clarity and transparency now in place one might expect big foreign investors to be lured back into the beaten up Japanese stock market. This should lift the second quarter performance of a number of Japan long/short equity hedge funds. Mahalo.

2008-05-14T06:38:00.000-07:00

Korea Readies Hedge Fund Market Opening

"A race horse that can run a mile a few seconds faster is worth twice as much. That little extra proves to be the greatest value."

John D. Hess

Late last year, various "voices" representative of political circles and the financial authorities in Korea announced that a proposed opening up of the alternative investment market would be brought forward from 2012 to 2009.

The motivation: to increase the efficiency and effectiveness of Korea's financial markets.

This could potentially be a BIG boost to Korea as a financial center, not so much because it will soak up investments otherwise directed at India or China but rather because it will probably compete closely with the region's number one laggard economy, Japan.

Korea stands to attract considerable attention from budding hedge fund managers because of the relative size of the financial markets; the vibrancy of its winning world-class brand name industrial concerns whether in autos, consumer durables and trading companies; the potential gains from a Korean perestroika from the opneing up of its northern trading partner on the penninsula; and, the arbitrage of the Korean Discount as political calm takes hold. In fact, it is worth remembering that Korea's financial markets held one of the lowest PE valuations in Asia (behind Thailand).

Of course, all it is not clear sailing for Korea to make massive strides. There is still a hint of insularity, opacity mixed with a strain of "national pride" associated with any attempts by foreign investor activists (Lone Star anyone?) to exert some shareholder responsibility on the still-closeted industrial face. This must change, if Korea is to succesfully vault ahead of Japan in terms of hedge fund market activity.

It is possible that Korea would be like Japan was in 2004. Then, hedge funds capital amounting to US$32 billion was evident in the markets, mostly in equities. However, then, Japan-specific long/short equity funds amounted to about US$28 billion. Today, most hedge fund assets trading Korea comes from global long/short equity shops, multi-strategy shops or those managers with a pan-Asian investment allocation approach. In the case of Japan, assets grew at a phenomenal 30% CAGR every six months through 2006.

The changing climate and attitude to alternative investments should also serve as a powerful signal to brand name HFoFs and private equity shops. Come and sell your wares! There are many deep pocketed insurers, financial institutions, trading companies, brokers and even pension funds that will be eager and willing product buyers.

Korean investors could be very signficant players in the global marketplace. Consider that Japanese institutional investors have over an estimated US$45-50 billion in global hedge fund product buying power. Expect marketing teams to stop off in Seoul, and prime brokers to show off their relationship "wares" in the very near future. Although, if 1Q08 hedge fund performance continues to disappoint one might see immediate demand for private equity, real estate and commodities on the Korean alternative investment shopping list. Mahalo.

2008-05-06T13:18:00.000-07:00

Japan Trading Companies Trawling Hedge Fund Eco-System

"It really gets my adrenalin flowing to hear the ping of the cash registers."

Stanley Kalms, b. 1931

One of Japan's largest trading companies, Mitsubishi Corporation, recently paid US$40 million for a 19.4% stake in the fixed income arbitrage hedge fund Aladdin Capital Management LLC.

Aladdin has approx. US$17 billion in assets under management many of them wrapped up in funds and a bevy of structured products, some of them that turned toxic towards the end of 2007 in the midst of the credit-crunch and the subprime meltdown.

A number of Aladdin's clients (mostly in Japan, and probably including Mitsubishi) were on the sore end of that trade. So what happened recently may indeed be the decision taken from one of these firms to "get closer" to the product manufacturer in the hope that once the dust settles they may be able to return to the fore attracting sizeable institutional allocations.

Unfortunatley, we live in times when labels themselves have become toxic. Institutional investors, including those in Japan, will not go near anything called fixed income arbitrage, relative value or even structured product or note. The fact is that association with these strategies has led to losses, and we are talking about big losses over the last 6-12 months.

Investors are not going to allocate to them for the time being. It is time for "wait and see".

Another trading company, Itochu, has a slightly different approach. They, too, started out as distributors in the early 2000s, initially using exclusive distribution contracts to share in the fees generated from selling these products to Japanese investors through their domestic broker-dealer network.

Itochu is famous for an initiative launched by Saito-san in the U.S. to expand into the seeding business. According to urban legend, Itochu gave CEO George Hall of the Clinton Group US$1 million in return for equity in his business model. This is how he started. Once this fixed income arbitrage operation had grown to US$5 billion, George bought out his Japanese seeder for around US$250 million. Saito-san was hailed as a genius and reported back to Tokyo in a senior management position.

Since then, Itochu is believed to have followed up its seeding initative with about 4-5 managers (mostly in the U.S.) with the model being to offer a slug of investment and working capital (US$10-25 million) in return for equity and exclusive distribution rights throughout the world - all this in the hope of finding the next George Soros or George Hall-manager.

They also bought out a hedge fund of fund operation in New York back in 2002 called Acam Advisors. All told, Itochu probably has exposure to hedge fund assets (single managers and fund of hedge funds) of approximately US$2.5 to US$3.0 billion.

Yet another trading company, Sojitz has also been active in the hedge fund business. It was originally a hedge fund of fund operation jointly owned by Nissho Iwai and Nichimen. Unfortunately, it started out with a focus on Japan and Asian fund of hedge fund product - an area that has been producing poor returns over the last few years. It probably has exposure to hedge fund of fund product to the tune of US$400 million (and falling).

Other major Japanese trading companies including Sumitomo, Marubeni and Mitsubishi, have all been active in the hedge fund business either as principal investors or as product manufacturers and distributors. It is believed that taken toegther this group may have a combined exposure of up to US$8-10 billion.

Given that Credit Suisse/Tremont broad hedge fund index has produced negative 2.01% over 1Q2008 one can expect internal pressure to mount within these trading companies to trim their portfolios, reduce exposure to volatile strategies and even to re-structure units if losses are steep enough.

Ultimately, some firms may be soon be forced to pull out of the business altogether, especially if end-buyers in Japan decide that now if not the right time to buy hedge fund product. A bumpy road lies ahead for many of these players. Mahalo.