Morgan Stanley's Kurt Baker, executive director in Hong Kong, and Victor Chang, managing director in Tokyo, discuss Morgan Stanley's prime brokerage business and the prospects for the hedge fund industry in Asia.
Are the poor returns in the traditional equities markets reflected in your pipeline of hedge fund clients?
Chang: The number of accounts we have and the number in the pipeline keeps increasing. On the Tokyo side we did not set up the business as early as the Hong Kong business, or as early as some of our competitors, but ever since we set up shop here the momentum has been picking up.
Goldman dominates in Japan. How do you compete with them?
Chang: In Japan Goldman had a team on the ground several years ahead of us. We used to cover Japan from our Hong Kong office, but finally put a team in Tokyo in late 2000. Our business is growing and we're the only prime broker that has dedicated account reps on the ground.
What do clients come to you for?
Chang: One area is capital introduction. Investors around the world have, at times, shied away from Asian equities because of political turmoil or, in some markets, inaccessibility to stock lending. When they start off, most of these funds have a difficult time getting up to critical mass. Helping these funds reach that level, $30 million or $50 million, is probably one of the common challenges for start-ups in this region.
Baker: A lot of hedge fund managers in this part of the world are coming out of large institutions where they have a value orientation and are fantastic money managers, but were not very active in the marketing side of their own business. So if you think about where they may have less comfort it may be in dealing with investors. It's not something they're used to.
They need access to European investors, to UK investors and so on. It's a mix of investors you want, a combination. You want to work for families, funds, endowments and fund of funds. You want a broad mixture of investors so you don't have volatility in the fund size as investors come and go.
Clients also seek our advice with regard to how to set-up their business. We've made a decision to dedicate resources to in-house management consulting in order to help our clients start their business. We seek to understand their needs and ensure anything we give them has a reason for being there. I often like to joke that if you give a client 100 computer applications and they only use five, then it's 95% useless.
How are things changing round the region?
Baker: One of the changes is the deregulation that took place in Korea last March in relation to foreign exchange regulations. That opened up a securities lending market there, which has also had a profound impact on our industry. Korea is a very large, very liquid market and often trades as much the Japanese market. It's deep and volatile.
Throughout Asia over the past year, absolute return has become a more important strategy. The frequency of start-ups has grown and the number of opportunities for funds has increased significantly.
Is the opening of the securities lending market leading to new business in Korea?
Baker: The new regulations are leading to more single country funds there and also to Korea being added to multi-country funds as securities lending is now possible. Korea is the most liquid country in the region, apart from Japan. It is obviously good for our business too. There has been a real shift in focus to north Asia. Korea, Taiwan, Japan and Hong Kong as a proxy for China, are all getting a lot more attention.
Chang: In Japan the stock lending market has officially been open for business since December of 1998 and has only grown in size. For prime brokers, 2001 was a lean year for new Japanese hedge funds, but 2002 saw over a dozen fund launches. The potential number of new funds in 2003 looks even larger. More Japanese institutions are setting up in-house long/short funds. That could be a potential breeding ground for future hedge fund managers setting up on their own.
Where are you seeing the strongest growth in your business?
Chang: Japan is a rapidly growing market, the number of onshore and offshore long/short funds have increased dramatically.
With the increasing business will you be expanding?
Chang: Since establishing a team, we have continuously increased our staffing, and are the only prime broker to actually have dedicated account reps here in Japan.
Baker: We're not recruiting at this moment, but as our business grows we constantly take a step back and review what we have. If we find that our service to clients is being diluted, or in danger of being, we'll recruit more people.
How do you see the hedge fund market in the region?
Baker: If you look at the assets in Asian funds, 2002 saw a 26% growth to $20.3 billion, that's $4.2 billion of new money coming into the sector. If you look at the performance of Asian funds last year, the average was 3.6% positive. That's very healthy. If you look at it from a liquidity perspective using a 90-day Treasury bill with an average yield of about 120 basis points, to say they are returning three times that yield, that's a very attractive return on a risk-adjusted basis.
Do you feel the scene for hedge fund managers in Hong Kong or Singapore has lost steam?
Baker: The hedge fund scene in Hong Kong is certainly not losing steam and in fact is gaining momentum. We're seeing more and more interest in starting hedge fund in Asia and interest from investors outside the region looking to invest here. Hong Kong especially has seen an inflow of assets, as has Singapore. Both places have favourable tax structures and even if a manager is trading in Korea or Japan they will often prefer to be based somewhere with a favourable tax system.
Have the new rules for retail sales of hedge funds had any impact on your business?
Baker: The new rules have had very little impact on our business. The majority of funds are boutiques and they don't want retail money, as it is complicated and very intensive. There was some interest in getting funds authorised for tax reasons, but now that issue has been resolved, that interest will wane. Where the new rules will have more impact is as more institutions get involved, as HSBC and JF have done.
What challenges do you anticipate in the next six months?
Baker: I think the challenge is going to be in the form of the financial markets and the degree of uncertainty. Our managers are facing difficult market conditions and we must be sure we are supporting them in every possible way. That being said, I am very optimistic: uncertainty will only increase the amount of money that is being allocated to absolute return strategies. Yale University, for example, has announced it is putting 25% into absolute return strategies. This is the kind of stuff that is getting people's attention. This business is not going to get smaller; it is only going to get bigger.