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Interview with Osamu Yamashita, CEO at SRF Group Pte. Ltd.

The firm, SRF Group Pte. Ltd., was founded in Singapore and is responsible for the investment decisions of SRF Germinate Fund as an investment manager. The firm currently operates in Singapore as a Registered Fund Management Company (RFMC) under the requirement to hold a capital markets services licence to carry on business in fund management pursuant to the Securities and Futures Regulations.

Through interest rate normalisation, in early 2012, we observed that many investors were seeking for alternative investments with less volatile and less risky products instead of bonds. At the same time they wanted to avoid facing fraud risks by investing in a single hedge fund, but were aware that it would be difficult to be free from these risks without professional experiences (and due diligence). To such consensus of many investors, we have decided to provide our FoHF scheme.

The fund's investment objective is to provide FoHF investors with attractive risk-adjusted returns, targeting an IRR of above 10%, with low volatility and a low correlation to traditional assets. To achieve this objective, the fund needs to be allocated to highly skilful 10 to 20 different hedge funds with considerable alpha potential.

We selectively allocate our fund not only to matured hedge fund managers but also to early-stage mangers. Early-stage managers could perform well, thanks to relatively small assets under management (AUM). We believe that some of them have better risk-reward ratios than matured managers.

Our total of over 20 years experience in hedge fund business allowed ourselves to build up networks in several industrial fields both in Japan and in Asia. With our profound knowledge of the life cycle of hedge funds, we are capable of providing our investors with information based on sophisticated analyses, especially for the investment in emerging managers.

Our Japanese equity-related strategies are the major contributors to our performance in 2013. We are always searching for an ideal market for our hedge fund allocation: the market in which we can discover a plenty of alpha sources. In 2013, Japanese equity markets were exactly our need. We therefore attached importance to it and our strategy has turned out to be successful. We would like to emphasise that the net equity exposure of the fund is merely around +20% over the period, that is, the majority of the profit came from alpha rather than beta. As for the Asia region, underlying funds in our portfolio also performed well. We had cautiously monitored Asian equity market, based on which we allocated Long/Short Equity, Equity Event Driven and Multi Strategies with low net exposure to the portfolio.

Three key factors to consider when we select a hedge fund are 1) a set of strategy and skill employed, 2) market environment, and 3) assets base. Additionally, from the portfolio construction perspective, our market view and portfolio diversification are also taken into consideration.

Past performances are important in order to evaluate a set of strategy and skill employed. As for a newly launched hedge fund, even if we need to evaluate it through limited information such as referable performances or short-term track records, we are confident about our investment decisions being made based on our past experiences.

Furthermore, our portfolio is composed of the mixture of early-stage managers and newly-launched managers. In case of investment in early-stage managers, we place much emphasis on stickiness of money: we will check the type of investors, founder’s asset situation and so on.

As of January 2014, 50% of our portfolio is dedicated to AUM to Long/Short Equities, 20% to Event Driven, and the remaining to Macro/CTA and Multi Strategy.

This is apparently a rough breakdown and in fact there are many types of strategies depending on the category. Concerning long/short equities, for example, some hedge funds focus on long-term view for stocks, while some other focus on short-term price movement, or mid-small cap stocks. Our portfolio is consisted based on many types of strategies and has been diversified well. And we need to keep our portfolio constantly well-diversified because market environment is subject to be a dramatic change.

Previously, our portfolio manager Yamazaki was managing Japan focused FoHF and although TOPIX index was down over 18% in 2011, his position was fairly flat. It is a good example to show that our portfolio diversification works well in spite of a market slump.

As was already mentioned, the fund is composed of 10 to 20 different hedge funds, and our portfolio is reviewed on a monthly basis. If the market environment significantly changed, our portfolio should also change in order to adapt to a newly established market environment. For example, in the previous company, the portfolio needed to be rebalanced to a considerable extent after the Japan earthquake in 2011.

Basically each underlying of our fund has a set of loss-cut point as a guideline. The threshold point we have set up is -10% (-15% for some funds) of latest peak NAV. Once the performance touches the threshold point, we would need to take certain actions in order to reduce impact from further underperformance: e.g. we may partially trim the position of some underlying funds. When the performance reaches -20%, we would need to fully cut the position.

We suppose that many problematic incidents with FoHF were observed during and after the financial crisis in 2008. We believe that these incidents were mainly caused by differences of conception of liquidity between investment-side and investor-side: some FoHFs undertook illiquid strategies even though they had promised to provide monthly or quarterly liquidity to their investors, which resulted in suspension of redemption request from investors, NAV calculation and so on. In addition, some highly leveraged strategies experienced a huge markdown during the financial crisis. This markdown affected performance of FoHF and triggered redemption from investors. This redemption led further drawdown. Although FoHF could have rebounded in the long run, its liquidation was unavoidable.

Hence our fund is not allocated based on illiquid strategies. We understand that liquidity risk and leverage risk are a part of alpha sources. However we recognise that the mismatch between the investment-side and the investor-side is much more problematic than opportunity losses for investors.

We monitor portfolio liquidity and leverage of each underlying funds on monthly basis through information provided by managers or risk monitoring company. If the managers decline to disclose this information, it would be difficult for us to invest. An audit report provided by a third party is also important to verify information provided by managers.

We employ a due diligence checklist which we developed internally. The objective of the checklist is to clarify a legal structure of a hedge fund, based on official documents. We also define on-site due diligence as one of mandatory process. We have to review operational flow by on-site visit before investment. We employ well-structured approach in operational due diligence, which would be made robust.

Our due diligence typically takes 1 to 3 months. But it depends on a hedge fund: if a structure is complicated, it would take much time.

Due diligence has been playing an important role for hedge-fund investments. It should therefore require a certain level of cost, either by direct investment or through FoHF. If an investor has much allocation to hedge funds, it is easy to cover the cost. But, for smaller investors it would not be easy. Hence, I believe there are many more potential demands for FoHF from smaller investors.

Regardless of whether single hedge fund or FoHF, for early stage managers including us raising money is much more difficult than before the year of 2008 but we are reasonably optimistic for raising money. We believe our strategy will generate high quality return and will be accepted by investors who seek high quality return in near terms.

As one of investors, we hope that the Abenomics will appear to be successful. However we ourselves are not optimistic enough to consider Nikkei 225 would continue to significantly rise in 2014. Nevertheless, it is true that thanks to Abenomics Japanese equity is currently focused, which is a positive factor for Japanese-equity-related hedge funds. The more investors participate in the Japanese market, the more opportunities we will benefit from alpha elements as a result of high transaction volume. Like in previous years, we would maintain low net equity exposure and focus on alpha potentials in 2014. Hence Japanese-equity-related hedge funds would be the star performers of our portfolio unless Japanese equity is no more focused.

Several potential risks remain in the Asia Pacific region, such as a possible outflow of money as a result of FED Tapering or a concern about shadow banking in China. However, market trend varies depending on several elements, let alone country, in the Asia Pacific region. Many profit-making opportunities for hedge funds should be hidden there. For example, the market trend of long-existing companies is different from that of newly-established companies such as IT companies even if their equities are traded in the same Chinese market: there should be opportunities if we skilfully use long/short positions. Our approach in 2014 would be basically to accumulate alpha elements through the movements of each individual stock. Thus our main strategy will be based on long/short equity, with low net exposure.

Like previous years, equity-related markets especially the Japanese equity-related market is attractive for us. We will continue to highly focus on alpha potentials and a low net exposure strategy. Our strategy with regard to other Asian markets is basically the same. Considering the potential risks already mentioned, however, diversification of the investment would be essential. We should therefore think about the allocation to Asian Macro Strategy

  1. Please share with us the key factors guiding your decision to launch the SRF Germinate multi-strategy fund of hedge funds (FoHF). In particular, what were some of the drivers that led you to time your entry into the market towards the end of 2012?
  2. What is the fund’s investment objective and style and how does it help in generating a competitive edge for your fund in the market place?
  3. The SRF Germinate FoHF is up an impressive 18.87% over the last 12 months. Could you shed some light on the fund’s key winnings broken down by both geographic and strategic mandate?
  4. What are some of the factors that you consider when allocating to a hedge fund (e.g. fund manager’s track record, strategy employed, assets base, fee structure, etc.) and how do these factors play out when allocating to a newly launched hedge fund?
  5. Can you give us a rough breakdown of your portfolio across the various hedge fund strategies? What safeguards do you have in place to manage your exposure across the various asset classes?
  6. On average, how many individual funds do you hold at any given point and what is your rebalance frequency? Are there any particular rules governing the rebalancing of your portfolio (e.g. mandatory quarterly rebalance)?
  7. Please share with our readers the details of your ‘loss-cutting guidelines’ if an underlying fund is consistently underperforming. How would these guidelines be amended so as to preserve the investor’s capital in the event of a market downturn?
  8. We understand that the SRF Germinate FoHF is committed to avoiding ‘excessive liquidity and leverage risk’. What processes have been put in place to monitor these risks and to what extent do they conflict with your goal of exploring new sources of alpha for the fund?
  9. Given the high-profile blow-ups and fraudulent managers over the years, operational due diligence has taken an important role in hedge fund investing. How robust are your processes in this regards and on average how much time does it take for a prospective hedge fund to successfully pass through your due diligence pipeline?
  10. The multi-manager model has witnessed a decline in its share of assets under management over the years as investors have increasingly sought to invest directly in the underlying hedge funds. In your experience, how difficult has it been to raise assets in such a market environment? Do you feel there is a need to upgrade the value proposition of the ‘fund of hedge funds’ model?
  11. We understand that the fund has considerable exposure to Japan focused hedge funds which have delivered excellent returns in 2013. What are your thoughts on Abenomics and do you feel it has run its course yet? Or will Japanese hedge funds continue to be the star performers in your portfolio in 2014 as well?
  12. With the Fed winding down its QE stimulus and emerging markets coming under the heat, do you foresee any changes to your regional exposure, especially for funds investing with an Asia Pacific mandate in the long/short equities space?
  13. Lastly, please share with us your near and medium term outlook for the markets. Which hedge fund strategies and what regions are you most bullish on?

Contact Details
Osamu Yamashita
SRF Group Pte. Ltd
+65 6808 5606