Interview with Neale Safaty, fund manager of the KBC Japan Fund of Funds

KBC Alpha Asset Management is the Fund of Funds division of KBC Alternative Investment Management. The two key principals, Neale Safaty and David Walter have 20 and 17 years expertise in Japan & Asian equity and equity-linked capital markets that includes broking, risk-management, trading and direct experience in setting up and running Asian hedge funds.

Interview with Neale Safaty

  1. How are the underlying hedge funds selected for your fund?

    We have identified 160 funds that are Japan-only or have a significant exposure to Japan. This includes long/short, merger arbitrage, distressed securities & real estate, options and CB arbitrage and equity statistical arbitrage. Weak managers and poorly run companies are removed at the outset. The process is dynamic, however, as new entrants are added and monitored. We then conduct qualitative research during one or more site visits where the managers and key support staff are interviewed. In addition each manager's return data is analysed and key statistics are calculated. Qualitative research is given priority over quantitative research. At the shortlist stage we leverage our longstanding independent professional network to assess managers credentials and conduct a thorough legal review. Potential funds are then evaluated for their risk-reward and correlation impact to the portfolio. Finally we ensure that our diversification objectives and risk management guidelines are not compromised.

  2. How would you describe the strategy of your fund and what % of the NAV is allocated to which sectors? What do you look for in managers in each strategy?

    93.5% equity long/short and 6.5% relative value.

    The mandate of the fund allows for investments across strategies. The universe of Japan absolute return funds is dominated by Long Short strategies and to some extent our fund reflects this. Within the Long Short spectrum, however, it is possible to attain diverse risk/return profiles that don't have a great deal of correlation. We do not think it is appropriate to invest in Japan CB arbitrage or real estate/distressed securities at this stage. We are however considering two corporate activity/ risk arbitrage type of funds to give us exposure to a different source of alpha.

  3. How long do you monitor a hedge fund manager before making an initial investment?

    Monitoring is a function of how well we know the key principals, whether the entity is an institution or a boutique, the track record of the fund and whether it is a start-up or a more mature fund. We can move rapidly and invest several weeks after we've initially seen a manager and we can commit on day one as an early bird investor. However, we do not seed or take equity stakes in investment management companies.

  4. What size are your initial investment?

    Initial investments in our Japan Fund of Fund are normally between $2 to $3million. We are in the process of constructing our Asian Fund of Fund and initial investments so far have been $1.5 to $2 million.

  5. What is your process of increasing investment from the initial investment?

    We have made additional investments in all our managers bar our most recently acquired fund. We consider our concentration risk guidelines, the overall potential volatility of the portfolio, the performance of the underlying fund and market conditions when directing inflows.

  6. What information do you require from the underlying Funds? How often is this information required?

    Naturally prior to investing in a manager we may require a reasonable amount of documentation as part of our due diligence. Post investment, we require Weekly NAV's, monthly newsletters and dialogue with the portfolio manager(s) when appropriate.

  7. How often do you visit the underlying managers? And examples of questions asked?

    Across both our Japan and Asian Fund of Funds, our managers are located in South East Asia, Japan, Australia, the UK and the US. We conduct investment reviews on site or in London several times a year. A benefit of being part of a large institution is that we can travel regularly and use KBC offices. We are also in regular communication with our managers including formal conference calls.

  8. Please explain the background of the manager(s) and analysts for the Fund.

    The two main managers at the fund have combined Asian experience covering the last 3 decades. Neale Safety specializing in convertibles and then Japanese Equity. David Walter having specialist expertise in risk management and over 6 years as a hedge fund manager.

  9. What type of risk management systems are employed by the manager(s). How often is this analysed?

    Qualitative risk
    Operational, legal and strategy risks are assessed during due diligence and monitored on an ongoing basis.

    Quantitative risk
    Key risk/reward individual fund statistics and correlation analysis is integral to portfolio construction.

    Monte Carlo Simulation Stress Tests are conducted and the portfolio has performed robustly, although they are of limit merit due to insufficient data.

    Investment process risk
    This is reduced through a consensus orientated Investment Committee.

    Organisational risk
    Risks are mitigated through the segregation of portfolio management and operational responsibilities.

    Risk Management Guidelines

    a) No single fund to exceed 20% of NAV. At the outset, an initial investment is normally less than 10% and typically will be 6-12% of the fund. If, through performance, an investment appreciates significantly towards 20% of NAV, the holding will be reduced or inflows or cash will be directed towards other funds in order to reduce concentration risk.

    b) No greater than 30% of exposure will be in underlying funds that have quarterly or longer redemption liquidity.

    c) Currency forwards are used to minimise Yen/US $ risk.

    d) The portfolio will not employ leverage other than to manage mis-matches between redemptions and subscriptions. This is limited to 10% of NAV.

    e) With respect to boutique managers, the fund will normally invest once assets under management have exceeded break-even levels for the investment management company.

    f) Top five positions will not normally exceed 50% of total assets.

    g) The fund will not normally own in excess of 20% of the assets of a single fund unless the fund is a small fund that is run by an institution that has significant assets under management and the fund is expected to grow in the near term.

  10. Can you describe the correlation of the underlying funds in the portfolio.

    We prefer to be discreet with respect to our underlying managers. The majority of our funds have less than a 0.5 correlation to both the portfolio, the equity market and to each other.

  11. Please describe the differences between building Asia fof vs Japanese fof ? Is it harder to find suitable Asian hfs vs Japanese equities long /short given that some view Asia as a harder place to operate as an hf compared to Japan where markets are deeper and more liquid?

    It was relatively easy to construct the Japan Fund of Funds because of our personal background in the Japanese capital markets, our professional network and our practical experience of the products and strategies. Asia is a different beast, we've found a broader range of opportunities but a wider variance in quality and greater strategy and entity risks.

  12. Japan hf performance: any differences performance and style wise between Tokyo, London and US based managers?

    We have analysed performance based on location because we thought intuitively domestically-based managers might have an edge due to ease of access to companies and advantages of operating during a live market. Our results were not statistically significant.

  13. It's been suggested in some commentaries that institutional investment from Japan in hedge funds worldwide has dropped off quite radically this year, is this something you've noticed and do you have any theories as to why?

    In our case we have seen inflows into the Japan Fund of Fund as it is distributed by Nikko Cordial in Japan. The outbreak of SARS inevitably restricted face-to-face meetings within the region and this may have caused a reduction in capital allocation from Japan.

  14. How do you see the future for Japan and Asian Hedge funds and fund of funds operating in this field?

    We are optimistic that there is tremendous amount of talented managers that are focusing on generating absolute returns from Japan and Asian capital markets.

    With respect to Japan, 70% of the universe has emerged in the last three years and we anticipate even more investor choice going forward. Nevertheless it is not a crowded field relative to the size of its capital markets and undiscovered compared to the US and Europe. We are excited by our partnership with Nikko Cordial in Japan as they have a strong tradition of distributing alternative products. With practically zero interest rates and poor returns from equities over the last thirteen years, low correlated, good risk adjusted absolute returns derived from markets that they are familiar with should appeal to local investors.

    Asia is extremely interesting. It is less mature, less sophisticated and culturally and economically diverse which potentially throws up enormous absolute return opportunity. In some sub sectors of the market place there are managers who are generating returns against very little competition. In the nine months we have been developing the product we have visited managers all over the world and discovered some excellent opportunities.

Contact Details
Neale Safaty
KBC Alpha Asset Management

Correction - Eurekahedge mistakenly reported on 1/7/2003 that the KBC Alpha fund would be launched in July 2003. In fact, the fund was launched in January 02. We apologize for any inconvenience this may have caused.