Tackling single-country Asian hedge funds
HFG and Hana Daetoo discuss conditions in the Korean market and predict an increase in hedge fund specialisation.
The HFG Korea Fund is a Korean-themed fund of hedge funds that launched late last year and currently has just under $30 million in assets under management. It targets returns of 12% a year net of fees with volatility of around half that of the Korea Composite Stock Price Index (Kospi). This is the first product from HFG Investments, a Singapore-based alternative investments joint venture between the Tom Picard/Tommy Kim-controlled Opvs Investment Holdings and its minority partner from Korea, Hana Daetoo Securities.
AsianInvestor spoke to Tom Picard, managing partner at HFG Investments, and David Bennett, who oversees Hana DaetooÆs hedge fund-related businesses, about the current climate for Korean hedge funds.
What themes are emerging from the Korean hedge fund managers you are meeting?
Picard: ThereÆs a great deal of conversation about the state of the won currency. Most of the funds we invest in are dollar-denominated and employ an equity long/short strategy so that results in two components to the fundsÆ overall performance, firstly how the underlying equity is performing and secondly, how they are playing the currency position. The won has fallen 10% to 12% in four months and nobody can really explain why the depreciation has been this steep.
Bennett: Each fund has to make a policy decision - that they either apply a consistent approach towards hedging or they make temporal choices about their approach to currency management. The other issue that weÆre hearing a lot about is to what extent a Korean-themed hedge fund should apply single-stock shorting or just use beta index shorting. Obviously, we are more interested in those managers who engage in the former, though this requires more skill to execute successfully. In addition, we are noticing that a number of Korea-focused managers are on the verge of launching, which we are following very closely.
Given there hasnÆt been much scope to short stocks in Korea before now, how can you deduce if new Korean managers have the skills to carry through a successful shorting strategy?
Picard: You can surmise from their prior experience. That might include working on a proprietary desk where a trader was allowed to short, or on the other hand they might have a background from a long-only mutual firm, where itÆs clear there was no exposure to shorting at all.
Bennett: Unless they have an existing track record, then you do not know for sure. Many of the managers in our universe come from a long-only background, and in the absence of specific shorting experience making the conversion to a more dynamic strategy can have an adverse effect on performance. As for availability, the prime brokers provide more depth and are more price competitive, particularly for the larger names, though we have spoken to some of the smaller Korean managers who say they are moving away from prime brokers for dependence on their shorts and doing it onshore through brokers via the Korea Securities Depository.
As the envisaged changes to the regulatory environment in Korea are gradually enacted, I think you may see more of these managers using local brokers rather than relying on prime brokers but given issues such as collateral transfer, size limits and other obstacles I think this will take some time. Until then, the larger managers will continue to find it much easier to obtain the majority of their short exposure synthetically through the prime brokers.
Do you think there will be a move back onshore by managers after the new regulations are rolled out?
Bennett: Yes, I think thatÆs what will happen eventually but you have a number of factors impeding that prospect, particularly in relation to regulation, taxation and infrastructure. There is a considerable amount of hype surrounding next yearÆs implementation of the Capital Markets Consolidation Act, but as far as I can tell the Act is largely silent on a number of key issues relevant to hedge funds, the use of shorting and leverage being two key areas.
As it is largely an offshore industry at present, how has that handicapped managers based offshore with their information gathering and stock insights?
Picard: Even if based offshore, hedge funds have conduits of information coming from within Korea itself, whether thatÆs from research providers or simply from flying backwards and forwards every other week. A lot of these managers have relatively small numbers of names in their portfolios, maybe 15 to 20 names. By virtue of their backgrounds, the hedge fund managers we invest in already have strong relationships with the CEOs and CFOs of the companies in which they invest. Consequently they have great access. It is not a great disadvantage being offshore. It doesnÆt take them out of the flow.
Bennett: Exactly. Most of the managers in our universe developed their skills onshore in Korea and make frequent trips to the country, and a number of them have onshore research offices upon which they rely for a considerable amount of their information.
How skilled are Korean hedge fund managers at capital raising, when it comes to selling their abilities to investors like yourselves?
Picard: The number one criteria that I look for is their ability to be clear about explaining their track record. ItÆs okay to have down months as well as up months. You can have terrible months as long as you can explain it thoroughly. If you can pull off a two percent decline against a 15% fall in the Kospi, you have to be able to explain how you accomplished it. Say, did two of your stocks do well at the same time as everything else got killed, did you have an effective index put strategy and so on.
If a manager canÆt explain the details behind his performance then it is possible they just donÆt understand why it happened. Of course we make adjustments for language issues seeing as they sometimes are explaining their performance in a second language; in fact, these very cultural or linguistic barriers create what we perceive as something of an opportunity for the likes of ourselves.
Also, many hedge fund managers come from a trading or running risk background and are not the guys usually responsible for marketing and client management. Therefore they may need help with marketing and raising capital to begin with. If you add on all those other cultural barriers, then it really helps to have someone in the middle like Hana Daetoo who can help investors sift through the issues. The lack of this generally is one of the reasons that Korea is so massively under-invested given the size of its economy.
Bennett: We want to see a defined process, not just running it by gut feel, which is a form of process risk that makes performance attribution difficult. So we look to see that they have a coherent system in place.
There are certain issues that make allocating to Korean funds an arduous task. Firstly, there is the act of simply identifying them. It is no easy job just to identify Korean-focused managers in the universe given that many do not report to the major databases, and when they do they often categorise themselves as being pan-Asia in nature. The other identification issue is caused by their origin, given that there are impediments to their establishing themselves in Korea for reasons I alluded to previously. Perhaps most importantly, the majority of the funds we cover are under the radar of institutional investors given their limited offshore track records and small asset sizes. However, we know these smaller managers well and some of them have been our best performers since inception.
Last year, single-country hedge funds were popular. This year, it doesnÆt seem to be such a hot theme. Has that made life harder both for finding managers, capital raising and performance?
Picard: Actually I would challenge the notion that more specialised hedge funds or fund-of-funds such as ours, which have a very specific geographic focus, is a temporary phenomenon. On the contrary, I think that going forward there will be increased specialisation of funds, especially in Asia as economies and markets continue to grow and expand. For a hedge fund manager to be successful, he or she needs to have a sustainable information advantage about their investments; the wider the scope of underlying instruments, industries or geographies traded the more difficult it is for that to be consistently achieved.
Bennett: Style drift presents a number of problems for an allocator. We have noticed some managers with Korean market expertise drift away from their area of core competence, presumably in an effort to make themselves appear more attractive to large investors. For us, this is a warning sign as we have observed that it typically has a negative or, at best, an unintended impact on returns and often leads us to question whether we should continue to be invested.
AsianInvestor spoke to Tom Picard, managing partner at HFG Investments, and David Bennett, who oversees Hana DaetooÆs hedge fund-related businesses, about the current climate for Korean hedge funds.
What themes are emerging from the Korean hedge fund managers you are meeting?
Picard: ThereÆs a great deal of conversation about the state of the won currency. Most of the funds we invest in are dollar-denominated and employ an equity long/short strategy so that results in two components to the fundsÆ overall performance, firstly how the underlying equity is performing and secondly, how they are playing the currency position. The won has fallen 10% to 12% in four months and nobody can really explain why the depreciation has been this steep.
Bennett: Each fund has to make a policy decision - that they either apply a consistent approach towards hedging or they make temporal choices about their approach to currency management. The other issue that weÆre hearing a lot about is to what extent a Korean-themed hedge fund should apply single-stock shorting or just use beta index shorting. Obviously, we are more interested in those managers who engage in the former, though this requires more skill to execute successfully. In addition, we are noticing that a number of Korea-focused managers are on the verge of launching, which we are following very closely.
Given there hasnÆt been much scope to short stocks in Korea before now, how can you deduce if new Korean managers have the skills to carry through a successful shorting strategy?
Picard: You can surmise from their prior experience. That might include working on a proprietary desk where a trader was allowed to short, or on the other hand they might have a background from a long-only mutual firm, where itÆs clear there was no exposure to shorting at all.
Bennett: Unless they have an existing track record, then you do not know for sure. Many of the managers in our universe come from a long-only background, and in the absence of specific shorting experience making the conversion to a more dynamic strategy can have an adverse effect on performance. As for availability, the prime brokers provide more depth and are more price competitive, particularly for the larger names, though we have spoken to some of the smaller Korean managers who say they are moving away from prime brokers for dependence on their shorts and doing it onshore through brokers via the Korea Securities Depository.
As the envisaged changes to the regulatory environment in Korea are gradually enacted, I think you may see more of these managers using local brokers rather than relying on prime brokers but given issues such as collateral transfer, size limits and other obstacles I think this will take some time. Until then, the larger managers will continue to find it much easier to obtain the majority of their short exposure synthetically through the prime brokers.
Do you think there will be a move back onshore by managers after the new regulations are rolled out?
Bennett: Yes, I think thatÆs what will happen eventually but you have a number of factors impeding that prospect, particularly in relation to regulation, taxation and infrastructure. There is a considerable amount of hype surrounding next yearÆs implementation of the Capital Markets Consolidation Act, but as far as I can tell the Act is largely silent on a number of key issues relevant to hedge funds, the use of shorting and leverage being two key areas.
As it is largely an offshore industry at present, how has that handicapped managers based offshore with their information gathering and stock insights?
Picard: Even if based offshore, hedge funds have conduits of information coming from within Korea itself, whether thatÆs from research providers or simply from flying backwards and forwards every other week. A lot of these managers have relatively small numbers of names in their portfolios, maybe 15 to 20 names. By virtue of their backgrounds, the hedge fund managers we invest in already have strong relationships with the CEOs and CFOs of the companies in which they invest. Consequently they have great access. It is not a great disadvantage being offshore. It doesnÆt take them out of the flow.
Bennett: Exactly. Most of the managers in our universe developed their skills onshore in Korea and make frequent trips to the country, and a number of them have onshore research offices upon which they rely for a considerable amount of their information.
How skilled are Korean hedge fund managers at capital raising, when it comes to selling their abilities to investors like yourselves?
Picard: The number one criteria that I look for is their ability to be clear about explaining their track record. ItÆs okay to have down months as well as up months. You can have terrible months as long as you can explain it thoroughly. If you can pull off a two percent decline against a 15% fall in the Kospi, you have to be able to explain how you accomplished it. Say, did two of your stocks do well at the same time as everything else got killed, did you have an effective index put strategy and so on.
If a manager canÆt explain the details behind his performance then it is possible they just donÆt understand why it happened. Of course we make adjustments for language issues seeing as they sometimes are explaining their performance in a second language; in fact, these very cultural or linguistic barriers create what we perceive as something of an opportunity for the likes of ourselves.
Also, many hedge fund managers come from a trading or running risk background and are not the guys usually responsible for marketing and client management. Therefore they may need help with marketing and raising capital to begin with. If you add on all those other cultural barriers, then it really helps to have someone in the middle like Hana Daetoo who can help investors sift through the issues. The lack of this generally is one of the reasons that Korea is so massively under-invested given the size of its economy.
Bennett: We want to see a defined process, not just running it by gut feel, which is a form of process risk that makes performance attribution difficult. So we look to see that they have a coherent system in place.
There are certain issues that make allocating to Korean funds an arduous task. Firstly, there is the act of simply identifying them. It is no easy job just to identify Korean-focused managers in the universe given that many do not report to the major databases, and when they do they often categorise themselves as being pan-Asia in nature. The other identification issue is caused by their origin, given that there are impediments to their establishing themselves in Korea for reasons I alluded to previously. Perhaps most importantly, the majority of the funds we cover are under the radar of institutional investors given their limited offshore track records and small asset sizes. However, we know these smaller managers well and some of them have been our best performers since inception.
Last year, single-country hedge funds were popular. This year, it doesnÆt seem to be such a hot theme. Has that made life harder both for finding managers, capital raising and performance?
Picard: Actually I would challenge the notion that more specialised hedge funds or fund-of-funds such as ours, which have a very specific geographic focus, is a temporary phenomenon. On the contrary, I think that going forward there will be increased specialisation of funds, especially in Asia as economies and markets continue to grow and expand. For a hedge fund manager to be successful, he or she needs to have a sustainable information advantage about their investments; the wider the scope of underlying instruments, industries or geographies traded the more difficult it is for that to be consistently achieved.
Bennett: Style drift presents a number of problems for an allocator. We have noticed some managers with Korean market expertise drift away from their area of core competence, presumably in an effort to make themselves appear more attractive to large investors. For us, this is a warning sign as we have observed that it typically has a negative or, at best, an unintended impact on returns and often leads us to question whether we should continue to be invested.
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