In this hedge fund interview of 2008, Eurekahedge explores the investment choices of Prodigal, a Cayman-based fund which was set up in 2005 by Michael Munns. A qualified actuary, Munns was most recently a global head of equity linked trading at Merrill Lynch and before that, a fund manager at County NatWest.
Today, Prodigal manages in excess of US$135 million across a range of strategies and markets. The portfolio is focused on Asian markets (ex-Japan), with a pre-disposition for developed markets.
- Many managers have been eyeing Asia as an investment region for a while now. What is it that draws you to investing into Asia? And, are the investments of the Prodigal Absolute (Cayman) Fund invested mainly in Emerging Asia, or are you looking at developed markets such as Japan too?
Prodigal focuses on Asia (ex-Japan) for a number of reasons: i) this is the time zone we chose to live in and we know the various markets well; ii) Asia is a hub of significant global economic growth generating numerous transactions which have the potential to suit our strategies; and iii) the markets in Asia are less developed in comparison to American and European markets, which translates into less competitive forces for our type of trading. As such Asia ex-Japan represents an excellent set of opportunities for our fund and the strategies we’ve deployed.
We are invested across most of Asia’s more liquid markets such as Hong Kong, Singapore, Australia, Korea, Taiwan, India, China, Thailand, Indonesia and Malaysia, and we run country limits according to set criteria.
If you define Emerging Asia as countries such as Vietnam, Philippines and Cambodia then NO; we are not invested in Emerging Asia.
How does this fund differ from the other funds that you manage? What competitive edge do you provide the investors of this fund with?
The Prodigal Cayman fund is run pari passu with our Prodigal Absolute Return Fund which is our domestic vehicle. Our competitive edge can be described as our ability to look at a range of transactions that are cross regional and inter-regional. Many of these transactions which involve multiple legs present some of the best opportunities for our type of multi-strategy fund.
- The strategy description of your fund states that it is a multi-strategy fund. How many different investment strategies have you adopted, and on what basis do you allocate assets to each of the strategies?
The fund is invested in a number of strategies focusing on distinct opportunities in Asian equity markets. The current strategies include portfolios focused on:
- statistical trading;
- convertible arbitrage; and
- risk arbitrage including capital structure arbitrage.
The allocation process between the various strategies is based on capital at risk and seeks to ensure the multi-strategy approach is maintained. We recognise the cyclical nature of markets and the ability of the strategies to perform at their optimum during different market cycles. When the strategies are combined as a portfolio they generate a higher return with lower volatility and are uncorrelated to other asset classes, than if they were used in isolation.
Statistical arbitrage is one of the various strategies that you use to deploy your fund’s investments into the markets. To what extent is your investment team involved in this strategy, and what portion of the investment research, process and execution do you bank on electronic models for?
Prodigal’s statistical arbitrage approach is somewhat different to traditional stat arb. Our model has a longer term holding period of approximately 30 days as opposed to a couple of days. The strategy is implemented on a daily basis by a dedicated member of the investment team and back-up analyst, who uses direct market access for execution of the model. A ‘sanity check’ is conducted on the model on a daily basis for instances such as where the model produces a short hedge signal on a stock that is a takeover target.
- As per recent Eurekahedge research, several quantitative model-driven funds were badly hit during the recent US subprime mortgage meltdown and the credit crisis that followed. What impact did that have on your funds? Did it require you to intervene in the functioning of the models you use (for the statistical arbitrage portion of your portfolio)?
The fallout of the subprime meltdown did impact our strategies and our portfolios. For example in August 2007, our convertible arb strategy lost money on widening of credit spreads, however this was offset by profits generated from gamma trading opportunities. As such the convertible arb portfolio was positive for the month of August. The risk arb book during August also faired reasonably well, despite spreads widening. This was due to a number of transactions that rolled off during August (approximately 25% of the book) allowing us to use the excess cash to go back into existing deals at better levels and new deals that presented excellent opportunities.
The recent equity market meltdown on January 2008, presented a number of challenges in that the gamma trading opportunities weren’t as prevalent and risk arb deals traditionally don’t roll off in January. Many of the risk arb transactions in our portfolios, while trading at widened spreads, are still very likely to roll off in coming months, indicating expected positive performance in the near future.
Our statistical trading strategy has been our most stable portfolio over recent months.
- On what basis and to what extent do you diversify your funds investments across sectors and regions within Asia? Being a manager that uses different styles of arbitrage, which of the regional markets are you most bullish on?
Our overall strategy seeks to be market and sector neutral. Our portfolios are diversified across numerous markets and sectors. In terms of regional markets, we see excellent opportunities in India, where we have already done a number of transactions, and other Asian markets that receive little focus such as Thailand, Indonesia and Malaysia. To date China has also presented a number of excellent opportunities for the fund. These opportunities still exist, despite global capital increasingly being focused on China.
- On an average, how many positions do you hold at a time? To what extent is the portfolio of the fund leveraged, and what is the usual ratio of long to short positions that you maintain?
The number of positions varies, largely dependent on how many positions the statistical trading model is running. Typically there are approximately 25-30 positions in the convertible arb book and about the same again in the risk arb book. The statistical trading book can add up to 100 positions just on its long side when it is fully deployed.
- One of your other funds (the Prodigal Absolute Return Fund), which is a relative value fund, returned an impressive 97.5% in 2006, while the Eurekahedge Asia ex-Japan Relative Value Hedge Fund Index advanced by a mere 22.2% for the same period. What would you attribute this notable performance to?
The performance of the Prodigal Absolute Return Fund (our domestic hedge fund product which is run pari passu to our Cayman fund) performed extremely well in 2006 for a number of reasons: i) the fund size allowed Prodigal to be very nimble; ii) all three strategies worked well during the year; and iii) there were a number of transactions in the risk arb book that received multiple bumps, especially during the month of October. We often get asked if these sort of returns are repeatable. While we acknowledge that everything’s possible, we tell potential investors that we are targeting returns in excess of 15% per annum (net of fees) and an annual volatility based on monthly returns in the range of 5-8%. This is what we achieved in 2007.
- What are the risk management tools you have in place, to protect your fund’s investments?
We run a top-down and bottom-up approach to risk. This sounds a little contradictory so I’ll explain. From a top-down approach we run VaR constraints and a return/risk valuation for the overall portfolio. At the top-down level we also run a maximum leverage, which constrains the long side of each strategy. These aspects flow into portfolio risks and the way we look at country risk, interest rate risk, currency risk and sector allocation.
The bottom-up approach focuses on transactional risks such as expected alpha, hedgability, deal terms and credit risk.
- What are the types of investors that have shown interest in your funds so far and what segment of investors is the Prodigal Absolute (Cayman) Fund intended to cater to?
We are receiving good interest from those investors looking to allocate to Asian managers and strategies, who are seeking non-beta returns. The broad cross-section of investors include private banks, funds of funds and family offices. Our international marketing efforts, which will be increased in 2008, have taken us to Hong Kong, Singapore, Switzerland, the UK and US. We have a number of clients out of Asia and growing numbers out of Europe and the US.
- What do you think of the present valuations in some of the regional Asian markets and how do these affect the investment strategies that you practice? Could you give us your short- and medium-term outlook of Asian markets?
We are not a fundamentally based valuation fund manager and so find it difficult to provide a comment on present valuations; however we do recognise that bullish to flat markets tend to provide a greater number of transactions in which our funds can invest into. That said we continue to see numerous deals coming to market that are candidates for our strategies. If markets go into an extended period of underperformance we expect our statistical trading strategy to perform solidly which should underpin the other strategies if there are a lack of deals coming to market.
Asia continues to have unprecedented economic grow and it remains to be seen whether it can become dislocated from a global economic slowdown. While there may be a few ‘bumps’ along the way it’s hard to see Asian growth slowing in the medium term. Hopefully this translates into strong performance for our Prodigal Absolute Cayman Fund for many years to come.
David Cambridge and Mike Munns
Prodigal Pty Limited
+61 2 8023 5700