Quest Capital is a Thai equities hedge fund with $160 million of assets under management. Its president, Doug Barnett, and portfolio manager Lance Depew met with FinanceAsia to explain how an alternative investment strategy works in Thailand.

FinanceAsia: How do you hedge in a market with no derivatives exchange?

Barnett: We hedge with cash, which is what makes us not a mutual fund. Thailand-focused mutual funds must be diversified and follow prudent-man rules. We, however, take very concentrated positions. Right now we've got 30% in cash, and 20% of the portfolio is in one stock, and 12% in another.

Why do clients pay you to sit in cash?

Barnett: They invest with us because it's about being in cash at the right time. We have a 14-year track record. We can preserve capital when the market is down and ride with the market when it goes up, by looking at value. Our fund has gained 1,573% in value over the last 14 years, as of April 30, 2004, while the stock exchange has lost 50%.

Depew: We live where we invest. We have an open dialogue with people here, we can establish relationships. And we can take significant positions, in some cases owning up to 20% of a company. In core positions we're often among the largest shareholders.

Barnett: We don't get any investment banking fees from these companies for advice. We only benefit if the stock price rises.

You're not licensed by the local authorities, so what investor protection do you offer?

Barnett: We're unlicensed by design because we only manage money from offshore. We're BVI licensed. What protects our investors is that Bank of Bermuda - now acquired by HSBC - is our fund administrator, Seward & Kissel is our lawyer and PwC our auditor.

Next year a future market is slated to open here. Will that expand your hedging possibilities?

Depew: I doubt the futures market will happen. And if they do create it, there's no institutional investor foundation to support it. We can buy Thai futures in Singapore, but they never trade.

Barnett: Hedging is a problem here. Not a lot of institutions are willing to lend their stock, even though they can get a 5% to 6% return domestically. So there's no short stock available. There's only three or four domestic lending agents; we deal with KGI Securities and Tisco Securities. But they don't understand the business. We usually have to beg them to cross it. Offshore, there's Citibank and Goldman Sachs, and that's about it. Morgan Stanley used to provide securities lending for Thai securities but won't anymore.

Why the lack of players?

Barnett: It's all subject to call on a day's notice. If you're long more than a third of a day's volume and it gets called, you get squeezed. It's just not prudent. There's only about $10 million worth that we can borrow, which means we can never be market-neutral unless we raise our own cash.

How do you control risk?

Barnett: We pick good stocks. Our fund goes down less when the market is cheap and goes up more when the market rallies. And that's because of our research. If we read something about a company in the newspaper that we didn't already know, we aren't doing our job.

How open are companies?

Barnett: There's no fair disclosure rule here. Companies will answer questions, but they just don't do it on a public scale. It's really a matter of dialogue. There are 50-60 companies with good, honest managers promoting good, niche products, and we'll usually hold around 10 of those stocks at any one time.

Depew: It's not an efficient market so homework pays off.

Barnett: The underlying economy here is vibrant. We've never had a government that was anti-business. That's important. So is Thailand's history and culture of entrepreneurialism and private enterprise.

In the short term, trading is dominated by housewives and retirees. The average account trades 100% of the portfolio 14 times a year. They don't look at value, just price movements. So prices can range from less than 1x earnings - which is less than zero enterprise value - to internet-bubble valuations. But on a three- or four-year horizon, there is a correlation between price and earnings.

What are the risks?

Barnett: Liquidity is the obvious risk.

Depew: Fraud and corrupt management teams. We learn from our mistakes which family groups to avoid. Fortunately we've always managed to get our money out. 1997 ripped the sheep's clothing off the wolves. It became clear which people would screw you when they were under stress.

Barnett: US accounting rules are so extreme, it allows the likes of Enron and WorldCom to manipulate them and hide things in special purpose vehicles. The accounting rules here are clear. Fraud is more blatant and straightforward. You've got to figure out who the good guys and the bad guys are. Experience helps. But there have been improvements here, too. Companies are more focused on investor relations, and there's more information available.

Depew: Sometimes a company's management is unsophisticated and pursues growth objectives it can never really meet. Sometimes the business environment simply changes. We had an investment in an electronics company that had a new product that could have made a killing. But by the time they rolled it out, they had missed their opportunity. Another time we got into a housing company that spent too much money on TV commercials.

Do you go after just smaller companies?

Depew: If it trades a few million baht a day, we'll look at it. But trading volume is more important than market cap, and 80-90% of Thai stocks trade enough.

Do you rely on external research?

Depew: We read everything. I'm a big believer in reading research about companies in other countries to understand industry trends. But in Thailand the quality of research cranked out by securities firms is pretty weak. The foreign firms generally have better coverage.

Any analysts in particular who stand out?

Depew: Generally, CLSA is very good, and so is ING. We like Daniel Tabush, the banking analyst at CLSA, and John Thompson at ING.

Is your fund still open to new investors?

Barnett: Yes, it is. Another $90 million would be nice.