The State of Hedge Fund and Fund of Funds Industries
Investor Select Advisors www.investorselectadvisors.com is a fund of hedge funds advisor, managing assets in 9 multi-manager portfolios primarily on behalf of institutional investors and distributors. It has in excess of US$340 million in assets under management, allocated to 57 hedge funds globally and over a dozen in the Asian time zone. Its 15 staff members include a research team of 6; 3 are located in Asia.
Peter Douglas has been researching hedge funds in Asia since 1998. He has 18 years' experience in the asset management industry, gained in London, Singapore, Sydney and Tokyo. After spending 10 years with the Foreign & Colonial group of asset management companies, he was a director of Aberdeen Asset Management Asia for 3 years before founding GFIA pte ltd, a strategy consulting firm focussing on the asset management industry in Asia. He has been managing director, Asia ex-Japan, of Investor Select Advisors, since 2001. Peter has an honours degree from the University of Exeter, UK, and an MBA from INSEAD, France. He was the founding honorary secretary of the Financial Planning Association of Singapore, and is the Council Member representing Singapore for the Alternative Investment Management Association.
Interview with Peter Douglas
- Is there a concern now that hedge fund investors are aggressively asking for capacity from new Asian/Japan hedge funds; and that subsequently your firm may have to rush its due diligence process to get into a start-up before it closes?
I still don't see that many managers, outside Japan, hitting capacity that quickly. There's just as many that are shutting down for lack of assets (including some arguably strong names, such as Blue Border). I think there's still a year or so before we really need to be chasing the brand new names.
Fortunately, ISA has analysts on the ground in Australia, Hong Kong, Singapore, and Tokyo; and has long-standing relationships in the region. This means we tend to get a fairly early 'heads-up' on new managers, and that, if we need to, we can get the groundwork done quite quickly. Generally, though, our portfolio needs drive our research process, as opposed to imminent manager closure, and we've not yet felt pressure to make allocations faster than we'd like.
In fact, I'd say that one of the most attractive characteristics of Asia right now is that there are a reasonable number of world class strategies, that typically do have capacity available, and allocators have the luxury of having the time to do proper research work before committing capital.
The flip side of that coin is that most Asian managers that I've spoken to who have been asked for capacity guarantees, see them as tactical agreements that they'll review once asset size builds. I therefore wonder how useful a capacity "guarantee" really is in practice (although it's undoubtedly a useful marketing tool for the fund-of-funds allocator).
What I do see, though, is that increasingly some allocators, especially from within the region, are asking Asian managers for fee deals and discounts as an incentive to support their new launches, and that bothers me. My personal experience over the years is that buying investment management skills on price is a strategy that often ends in tears.
- As an investor based in Singapore, are you finding interesting new launches in the City?
Although I'm based in Singapore, I don't really see myself as a Singapore investor - it just happens to be where I live! It is however one of the easiest places from which to run a regional "knowledge business" such as a hedge fund. I'm the AIMA council member for Singapore and we've seen membership grow over the past 18 months from two firms to over a dozen now, including a couple of major institutions as anonymous members. Another phenomenon is that some managers (Speedwell, for example) are putting satellites in Singapore. I think this is driven by Singapore's very low cost of establishing and running a business, and its comfortable "Midwest" lifestyle, rather than any overwhelming strategic imperative.
What should the role of the Singapore government be in supporting new hedge funds in the City?
My personal view - with which some would disagree - is that the government should keep well clear of trying to stimulate the domestic hedge fund industry. Hedge funds inhabit a Darwinian environment, so making it easier for managers to set up here would risk breeding weaker players and - more importantly - developing a reputation for Singapore as a haven for second-tier managers. However, public sector institutions are beginning to allocate to hedged assets (mostly global best of best, for now) and that builds visibility and credibility for the industry. That's valuable.
- With the recent clarification by the Singapore government regarding investment in registered fund-of-funds and hedge funds, are you expecting local retail investors to be a lucrative area to raise money for Investor Select Funds?
No. We build fund-of-funds primarily for specific clients;. so unless we work with a local manufacturer there is not much interest for us in Singapore retail. Furthermore, the retail market right now is all about structured product - the terms of the structure are what sells, and the underlying asset is far less important, whether it's an equity index or a hedge fund. Institutional may be more interesting, and there's considerable existing demand from "high net worth" investors with offshore assets.
- With the opening of stock lending in South Korea, there is the expectation of many more Korean-only hedge funds starting up in the next 12 months. Do you think these would be of interest to fund-of-funds managers?
I've reviewed a number of pure Korean funds, but haven't yet found one that would fit our portfolio needs right now. We find the risk of a single-market Asian hedge fund difficult to deal with in a fund-of-funds context and so have hung back, though that stance may change in the future. However more aggressive investors should find some rich pickings in the newer Korean managers, especially in 12-18 months' time when they've got used to running the short side of the portfolio. There are also some very interesting opportunities to trade volatility in Korea. Although there will be some managers looking exclusively at Seoul, I suspect that the bigger story (and the bigger source of capital) will be existing Asian and global players increasing their exposures to Korea.
What could be some of the biggest issues concerning the Asian hedge fund industry in 2003?
In the very near term, many managers are feeling thoroughly 'whiplashed' by 2002; and rebuilding exposures, rethinking risk controls and portfolio construction, and looking for themes and trades with confidence, may slow many regional managers.
Further out, the ratio of capital made available, to opportunities made available, will be more acute in 12 months' time. Although I don't think there's an imminent capacity crunch, the capacity of the underlying capital markets in the region is limited and if investment in Asia does become fashionable, aggregate returns could drop rapidly.
- What are some of the biggest market risks for Asian hedge funds in the next 12 months?
One man's risk is another man's opportunity, so this is all about the characteristics of the Asian markets over the coming year. I'm not a macro guy, but it strikes me that the biggest continuing trend in Asia is how the local bourses are globalising; that the same influences that drive the US equity markets, for example, drive Asia: institutionalisation, the disappearance of the individual investor (he's buying mutual funds or day-trading froth), the absence of liquidity in second-line names, the implosion of trading costs, the increasing choice of derivative products, etc. There are still plenty of opportunities in Asia but it's not the same place it was pre-crisis, and post-crisis it's becoming a collection of mini-me markets. The other main implication of this trend is that Asia is judged alongside major markets as a competitor for investor capital - and, despite valuations and mis-pricings, the "micro-cap" nature of Asia is sidelining the region. From a global perspective, Asian capital markets are increasingly made up of a myriad of micro-caps, special situations, distressed assets - and a homeopathic sprinkling of maybe a couple of dozen liquid names across the entire region.
There will continue to be a great supply of distressed assets, with the People's Republic of China increasingly proving fruitful. The fixed-income markets, especially corporate, will continue to deepen as Asian corporations manage their balance sheets in a more sophisticated fashion. We may see (or I may be predicting this again for 2004!) some real substance to the M&A market, and therefore some event-driven opportunities in the region. The real shift is the marginalisation of Asia. Managers may be able to find better stock to borrow than a couple of years ago, more fixed income, etc… but fundamentally, liquidity is scarce and getting scarcer, and returns are getting lumpier. For some managers and strategies, that's a boon, for some, it'll be terminal.
- Should the decrease in liquidity across the region be a major concern for hedge fund managers?
Yes, though as I've said, only a handful of Asia ex-Japan managers are remotely close to capacity so it's not yet life-threatening. I think it's a big concern in Japan; some managers I speak to have quietly halved their estimates of their strategies' capacities during 2002 - the flip side of that may be that some of the largest funds that were at -or close- to capacity at the beginning of the year must be in the red zone already. I also think that the "long clever small cap, short dopey dinosaurs" strategy of many Japan long/short managers is carrying increasing risk on the long side. Maybe we're close to the bottom on the Nikkei and we'll be carried up by the market, but I'd still look closely at portfolio liquidity in Japanese managers.
As I mentioned earlier, the marginalisation of Asia is causing some structural changes in the way capital markets in the region are functioning, and I look for managers that have understood that structural change and are doing something about it.
Do you believe that the risk control systems for managers in the region have improved significantly over the past year?I think one of the characteristics of the industry in Asia is that it's unapologetically dynamic. Many managers are running their first hedge fund; market characteristics are still changing rapidly; investor activity is developing, etc. One of the things I look for is the degree of organisational learning and appetite for internal change within a manager. Part of that is, of course, developing risk controls. So yes, many managers now have markedly different - and, on the whole, I believe more effective - risk controls compared with their initial phase, and that's admirable. I've invested with more than one manager that I wouldn't have considered initially, as not having the right controls in place (or not implementing those controls properly), but who has developed sufficiently over the years so as to instil comfort.
Are you finding Asian investors interested in Asian or Japan-only fund-of-funds?There's huge interest in pure Japan fund-of-funds. I think the world has understood that regardless of what does or doesn't happen at the policy level, micro Japan is mutating rapidly, and that must create big opportunities on both sides of the balance sheet, and therefore Japan long/short equity, mainly, is the way to go, and that understanding these managers takes specialist research. One of the characteristics of the Japan space is how geographically spread it is. Our Japan fund-of-funds product uses managers in the U.S.A., London, Tokyo, Hong Kong, Singapore, and Sydney - we have analysts working in each of those locations and you really need that global reach to do Japan well.
We don't see a huge demand for Asia ex-Japan fund-of-funds at the moment. I believe it's an attractive asset class, not because Asia is sexy, but because you can access an interesting pool of non-correlated talent that still has good capacity. That's not a high-profile story, and for now we don't have much capital invested relative to the research effort I've invested over the years in Asia. Much of the demand that my managers are seeing is from global portfolios adding in some Asian capacity (which we are also doing), which is an entirely sensible diversification now that there is sufficient quality in Asia.
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