KGR Capital is a new entrant in the Fund of Funds world, and one of the few to specialise in Asian hedge funds. Eurekahedge talks to one of the principals, John Knox:

Interview with John Knox

1. Who are KGR Capital?

   KGR Capital was founded late last year by three principals - Christopher Rampton, Nick George and myself. Between us we have about 65 years of experience dealing in Asian markets, covering equity broking, trading, derivatives and risk management. We have all worked together for about 10 years, first with Jardine Fleming, and then with JPMorgan, where Christopher Rampton was head of the institutional equities business in Asia Pacific. My personal background is in equity derivatives and I have been in Asia for the last 10 years, during which I set up and was responsible for the equity derivatives group in Asia for what was then called Jardine Fleming. Nick has been involved in Asian markets for 20 years, heading up various institutional and corporate broking groups, most recently for HSBC.

   We are based in Hong Kong, and we expect to open an office in London soon. The Asia Pacific Absolute Return SP, which started trading on 1 August 2003, is our first fund and invests in hedge funds focusing on the Asia Pacific region.

   You should check out our website www.kgrcapital.com.
   

2. The fund of funds market is getting very crowded with many new entrants, and scale is important given the cost of the research and investment professionals required - how are you going to achieve this?

   We think that the fund of hedge funds market in Asia is still in its infancy. There are currently just over 30 fund of hedge funds focusing exclusively on the Asia Pacific region, mostly small, with cumulative assets of less than US$1 billion. These numbers are very small compared to estimated assets under management of about US$28 billion for Asia Pacific hedge funds, which have now grown to over 300 in number. We think that most of the growth in the Asian hedge funds is yet to come, driven by increasing allocations to Asian managers as the hedge fund industry matures and the underlying capital markets attract more capital and become more liquid.

   We have built a team of motivated and seasoned professionals from a number of different disciplines, with many years of experience in the Asian markets and risk management and we believe we are very well placed to make a significant contribution to this specialised area.
   

3. Why do you think investors should invest in a Fund of Hedge Funds?

   There are many reasons why some investors prefer funds of funds, but the two main areas where a fund of funds can add significant value for an investor are risk management and the ability to conduct a thorough due diligence of the underlying hedge funds.

   At KGR Capital, we currently have about 20 different hedge funds in our portfolio, with funds pursuing a range of different strategies spread across the different countries and capital markets of Asia Pacific. This degree of diversification provides investors with a very significant reduction in overall risk levels when compared with an investment in a single manager hedge fund. We also employ a number of sophisticated quantitative techniques, which our research indicates helps to reduce the risk further, including co-variance optimisations, and VAR calculations.

   It is of course also important to invest in the right hedge fund, and that is again where a fund of funds should also be well placed to add value. It is important to have a thorough understanding of the strategy employed by the hedge fund manager and to really understand how they make their returns, as well as the risks involved in the process. This includes operational and legal risks, and not just investment risk. It is particularly important in the current environment of rising markets across Asia to be able to distinguish between good managers and poor managers who are just plain lucky. This involves a significant investment in people who have the experience to go in and really understand what is going on.
   

4. How do you persuade investors that paying performance fees twice is a good thing?

   In our view, if a fund of funds can significantly add value to the investor, by reducing risk, improving returns, or even just saving time, effort and angst, it's a fee worth paying. If performance results are good and investors like the team and the infrastructure, in our experience, they do not mind paying the fees.

5. What do you think are the main advantages of Asian hedge funds as opposed to European and US hedge funds?

   The Asian hedge fund industry is relatively new and is still small, but it has significantly outperformed global hedge fund and major equity market indices over the last three years, and perhaps surprisingly, with lower levels of volatility.

   We believe that this relative out-performance is set to continue over the next few years. We think that this will be driven by the significant inefficiencies inherent in a region comprising 12 or 13 countries, each with their own legal systems, currencies and capital markets, most of which have not fully recovered from many years of bear markets and recession.
   

6. Equity markets have performed well recently. How has the KGR Capital Asia Pacific Absolute Return Fund performed over the last 3 months? What returns and volatility are you targeting?

   We are targeting returns of 10-15% pa. Obviously this will be higher in good years, and a bit lower in the bad years. In August our fund was up 2%, September was up 2.4%, and we are optimistic for another good month in October. We are very focused on risk management and capital preservation, and are therefore targeting a low volatility level for this fund, aiming for annualised volatility of between 3.5 to 5.0%. Although it may be a bit early to be saying much about our volatility, we are currently well within this range, with a pro-forma figure of 3.6%.
   

7. How would you describe the strategy of your fund and what % of the NAV is allocated to which sectors?

   The fund is a multi-manager multi-strategy fund of Asian hedge funds. Asia for us includes Japan, Australia and the Subcontinent. It minimises risk by diversifying across strategies and managers. We currently have about 20 managers in the portfolio and are looking to add a couple of new managers over the next few months. We are also well diversified across strategies, with more than half the portfolio committed to market neutral, distressed debt, fixed income and equity arbitrage funds that are largely uncorrelated to directional movements in the equity markets. The rest is invested in nimble long-short equity funds that can capture upside in the booming equity markets and reduce their exposures in times of market decline and volatility.

8. What is your investment process? Are you top-down or bottom-up? What do you look for in managers in each strategy? How are the underlying hedge funds selected for your fund?

   We are both top-down and bottom-up. The first bottom-up stage involves us looking through all of the 300 or so funds which match our criteria of being invested in Asia Pacific. We are looking for managers that have a credible track record, and are supported by a robust infrastructure.

   The second phase is the portfolio construction, which in turn is both quantitative and qualitative. We do use a number of quantitative techniques, including co-variance optimisations, but then we add a human element, and will tilt the portfolio towards the strategies that the Investment Committee feels are most appropriate.

9. How often do you visit the underlying managers? Please provide examples of questions asked?

   We meet our managers frequently and have regular phone conversations with them. We make data requests on a regular basis and track performance attribution, exposure levels, performance drivers, strategy drift, etc. We monitor performance of our funds at least on a weekly basis and more frequently in the event of major market movements or dislocations. We do not want to micro manage, but we put a big premium on transparency, openness and access.

10. Do you invest in start ups? If so what are your selection criteria and what % of the fund is balanced with those of managers with a proven track record?

    We do not have startup investments in the portfolio at the moment but would be ready to invest a small proportion of the fund in promising start-up managers. A significant proportion of our fund is invested in well-established managers with at least a two to three year track record.

11. What is KGR Capital's edge?
    

    Our biggest edge is Asia. We feel that it is a very big advantage for us to have so many years of experience and such a deep knowledge of the Asian markets that underlying hedge funds are trading. In many cases we have first-hand experience of the products and strategies that they are trading, and we also know many of the hedge fund managers personally.

12. Is it harder to attract investors in the current bull markets? How has the capital raising been for your product?

    We believe we have appeal in bull as well as bear markets. It is true that there is a tendency for money to chase direct equity exposure in very bullish markets. However, the sharply increased levels of capital flows into Asia and into equity markets, increasing investor comfort with hedge fund products, and an increasing investor preference for downside risk limitation are resulting in strong inflows of funds into alternative investments.

    We are very pleased with the way that our capital raising has been going. Initially we focused more on building the infrastructure and getting the product side right. Now that we are comfortable with this, and we have a couple of solid months behind us we are concentrating a little more on marketing, and I am pleased to say we have been attracting some very high quality investors, and we have now seen assets under management double since we launched in the summer.

Contact Details
KGR Capital Limited
Hong Kong
+852 2843 6888
www.kgrcapital.com