Welcome to the vortex.

First Bear StearnsÆ high-grade structured credit strategies fund and its high-grade structured credit strategies enhanced leverage fund managing $2 billion of assets were sucked in; media reports suggest $1.5 billion has been destroyed, forcing the Bear to suspend redemptions.

Hands up: who thought Bear Stearns would be the first harbinger of the latest financial maelstrom? Who saw that one coming?

The contagion is spreading. Dillon Read, a hedge fund owned by UBS, closed after losing heaps on sub-prime exposures. The US hedge fund Sowood was next in the crosshairs, and is now being forced to liquidate positions to Citadel Group for a song. Horizon ABS Fund has had to suspend redemptions. This week it was announced that two Fortress funds run by Macquarie are suffering 25% drawdowns.

The meltdown is creeping closer to the Orient, as Aussie hedge funds Basis Capital and Absolute Capital are swept in.

Hedge-fund managers have told AsianInvestor that some sub-prime positions, understood to belong to Basis Capital, are being hawked around the market at valuations far inferior to the recovery values that the media is reporting.

We asked around a selection of some of the best known funds of funds in Asia to see how they were invested and how they felt about placing such strategies in their portfolios.

AsiaÆs forte in the hedge fund world of course is equity long/short, and so for once, happenstance has it that they have not been exposed to credit strategies. Most Asian hedge funds have avoided the titillating returns of CDOs and below investment-grade sub prime instruments, the so-called ætoxicÆ tranches.

ôWe werenÆt invested in Basis Capital,ö says Peter Douglas of GFIA pte in Singapore, a hedge fund advisory that also runs discretionary funds of funds. ôNot because weÆre perspicacious geniuses, quite the reverse: weÆve looked at a number of CDO-trading strategies and to be honest we just couldnÆt understand what the drivers really were. WeÆre æbears of small brainÆ. Conversely we did understand Basis CapitalÆs fixed-income strategies, though never actually invested there either.ö

Some funds of funds, like Persistent Edge, have totally steered clear of these types of strategies.

ôNo, we werenÆt invested in Basis Capital,ö says Raj Mehta of Persistent Edge in San Francisco, noting his firmÆs investment philosophy avoids risk-premium strategies.

Other Hong Kong-based funds of funds report they had at one point been invested in Basis Capital, but insist they pulled out before it all went pear-shaped.

ôWe had redeemed from Basis nearly three years ago and have not re-invested back since,ö says Jerry Wang of Vision Investment. ôWe have been bearish on credit. Therefore, the allocation in our portfolios is with managers holding the same view. As a result, our portfolios should benefit from the spillover effect of the sub-prime problems.ö

Vision has taken it a step further, putting on protective hedges to mitigate the downturn, Wang adds. Its Asia Maximus Fund initiated a hedging overlay on the H-share index and the Hang Seng Index as of last Friday. ôWe should do well on a relative basis if the market turns more negative,ö Wang explains.

Man Investments told us that they were not significantly exposed to Basis Capital, and that if they had any material negative exposure, it would be transparent for all to see, because they would have had to inform the London Stock Exchange as well as the UKÆs Financial Services Authority. ManÆs spokesperson says there is some exposure via its fund-of-funds business, but as this was net short, the firm has actually benefited from the situation.

These examples demonstrate how portfolio construction, a skill that funds of hedge funds are always ranting on about, can benefit their business. US-based hedge funds like Paulson & Co are making obscene profits because of its shorts against US home equity loans, and their head of investor relations James Wong is often seen jetting around Asia. You have to assume then that some local funds of funds must have Paulson in their portfolios. So if, in your fund of funds, youÆve got credit strategy funds such as this one taking an aggressive short approach, youÆve got to be smiling.

ôBeginning in 2006, many of the credit managers in our investment pool, which tend to be research-driven, have been moving to a short stance on tranches of sub-prime ABS CDOs,ö says Mark Reinisch of fund-of-funds player FRM. ôThey believe this to represent a good risk/reward trade, especially in the mezzanine tranches.ö

Naturally, even on a portfolio basis, losing an entire hedge fund from a blow-up is going to sting nastily, even if other investments are making marked-to-market profits. Nevertheless, given that this developing trend is so crystal clear, it is worth investorsÆ time to check with their fund of hedge funds (all of whom seem to attest to top quartile due diligence skills) about their status on credit strategies. The ones we have spoken to are philosophical rather than worried, probably because the impact on them is neutral or positive. For those funds of funds coy about talking to us, perhaps the picture is different.