The Brave New World of Hedge Funds in Asia

Paul Smith Hong Kong, May 2011

• Shape of the Global Industry

• Shape of the Asian Industry

• Winners and Losers in Asian Hedge funds

• Foreign vs Local

• Developments in Asia Hedge Fund regulation

• Challenges ahead

Introduction

2

February 2011 AuM

(US$bn)

Performance-based

growth/(decline) (US$bn)

Net assetflows

(US$bn)

March 2011 AuM

(US$bn)

% Change in assets

Hedge Funds

1734.9 4.5 13.9 1753.4 1.1%

By Geographic mandate

Asia ex-Japan 114.2 1.0 0.5 115.7 1.4%

Japan 15.6 (0.1) 0.1 15.6 -0.1%

Europe 392.2 0.6 4.5 397.3 1.3%

Latin America 61.3 0.5 0.4 62.2 1.5%

North America 1151.6 2.5 8.3 1162.4 0.9%

The Global Industry

Source: Eurekahedge April 2011 Asset flows update

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The Global Industry

57 6169

81

105

119126

134 135142 147 151

161

137

117 114106 109

0

20

40

60

80

100

120

140

160

180

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

$1,400.00

Jun-

02S

ep-0

2D

ec-0

2M

ar-0

3Ju

n-03

Sep

-03

Dec

-03

Mar

-04

Jun-

04S

ep-0

4D

ec-0

4M

ar-0

5Ju

n-05

Sep

-05

Dec

-05

Mar

-06

Jun-

06S

ep-0

6D

ec-0

6M

ar-0

7Ju

n-07

Sep

-07

Dec

-07

Mar

-08

Jun-

08S

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8M

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9Ju

n-09

Sep

-09

Dec

-09

Mar

-10

Jun-

10S

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0

Source: ‘Once titanic industry turns around to grow by 4.82%’ Hedgefundintelligence.com March 3rd 2011

Fund of Funds Billion Dollar Club assets evolution since 2002

• 33% of the 109 billion dollar FoFs experienced outflows in 2010

Size (US$ million)

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The Global Industry

0

10

20

30

40

50

60

70

80

90

100

2003 2004 2005 2006 2007 2008 2009 2010 2011

HFRI Fund Weighted composite Index - Percentage of constituent funds at high watermark (HWM), 2003-Q1 2011*

% funds at High Watermark

Max: 88% in 2007Min: 50% in 2009

Still in recovery

• 65% of funds have reached their individual high water marks

Source: Hedge Fund Research, global Hedge Fund Industry Report –first Quarter 2011 www.hedgefundresearch.com

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We are boutique not institutional sized

* Asia-Pacific including Japan

• Hedge fund leverage still below 2007 peak• 935 new launches in 2010 – most since 2007

Out of $130bn, i.e.35% managed by 15 managers

Source: Hedge fund Intelligence

6

The Asian Hedge Fund Industry

Source: Eurekahedge

Growth of the Asian hedge fund industry AuM growth in recent months

7

The Asian Hedge Fund Industry

0

50

100

150

200

250

300

350

2005 2006 2007 2008 2009 2010 Feb-11

LaunchesClosures

• Dream is still alive

• Average age of Asian Hedge funds is 3.7 yearsSource: Eurekahedge

Number of Funds

Launches and closures across Asian Hedge Funds

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The Asian Hedge Fund Industry

History- Late starter - shorter history compared to US/Europe- Smaller startups and smaller funds- Fewer 2nd or 3rd generation managers- From fringe to core allocation for global investors

Market and participants

- ‘Asia’ is not a single market…14 countries- Ideal size smaller…sweet spot $250m- Still a lot of boutiques rather than asset-gatherers- Liquidity is fickle, shorting is harder, less leverage- Few domestic institutions….retail/foreigners dominate- Less M&A activity…but growing

Business and funding

- Harder to get started…but easier/cheaper to operate- Traditionally reliant on European FoF…now Madoff’d- No domestic Asian institutional investor base- Independent administration, low operational risk

Does the Asian hedge fund industry have unique characteristics?

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The Asian Hedge Fund Industry

Lots of GDP growth, lots of volatility, no fees, …..and no return

Annualised return 0%

Annualised volatility 21%

0.4

0.6

0.8

1

1.2

1.4

1.6

12/1/1987 12/1/1992 12/1/1997 12/1/2002 12/1/2007

MSCI Asia Pacific - Indexed returns since 1988

What has passive exposure to Asian markets delivered?

Source: Bloomberg

10

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Dec-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09

Indexed Returns – Asian hedge funds vs. MSCI Asia

Eureka Asia Pacific Hedge Fund Index (incl Japan)MSCI Asia Pacific

Alpha in Asia…but take with a grain of salt

Compounding works……given time

The Asian Hedge Fund Industry

Source: Eurekahedge/Bloomberg

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Asian Hedge funds Winners & Losers

What do clients want?Priority Local Investors Foreign Investors

High Risk Investment

1st choice Greater China Equities Long Only Equity

2nd choice N/A Event Driven

Low Risk Investment

1st choice N/A N/A

2nd choice N/A Fixed income/RV/Vol

Small or large AUM

- Small or Large Large only

Start Ups - Y N

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Asian Hedge funds Winners & Losers

Top 10 Myths of Asian hedge fund investing (maybe…..)

Myths True False1 Managers are all about Beta and don’t protect capital

2 Managers don’t understand risk

3 Managers are mostly equity long-short, and even those are long biased

4 Liquidity is an issue

5 Shorting is difficult

6 Restrictions on foreign investment, poor information

7 Debt markets are undeveloped

8 Managers’ operational infrastructure is weak

9 Managers are not transparent and different due diligence is required

10 Regulatory oversight is weak

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Asian Hedge funds Winners & LosersWhat’s recently changed in Asian hedge funds?…..the paradoxes

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Asian Hedge funds Winners & Losers

China travel

Urbanisation

Motivated/distressed sellers

Active stockpicking (not benchmarks)

Local Asian franchises

Consumer, education, healthcare, environment

Cheap US companies with Asia exposure

Seeding/acceleration capital

Trade finance

Illiquid vs. liquid,

Smaller vs. large,

Boutique vs institutional

RMB liberalisation/ China big bang

Family co-investments

China A shares 50% off peak

Frontier markets

Asian High Yield bonds

Asia ex J volatility

Asian hedge and long-only funds

Japan restructuring!

Asian private equity fundsAsian fx

Asian opportunities – prepare to be a little different

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Asian Hedge funds Winners & Losers

• 59% still not to scale• Is <$100m enough in the current market?

Breakdown of the hedge fund population by fund sizes

Source: Eurekahedge

<$20m 37%

$21-50m22%

$51-100m11%

$101-200m14%

$201-500m13%

$501-1000m

2%

>$1000m1%

February 2007

<$20m 33%

$21-50m26

26%

$51-100m14%

$101-200m13%

$201-500m9%

$501-1000m3%

>$1000m2%

February 2011

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Asian Hedge funds Winners & Losers

Long/Short Equities

62%

Macro5%

Multi-strategy11%

Others1%

Relative Value2%

Arbitrage4%

CTA/Managed Futures

5%

Distressed Debt4%

Event Driven5% Fixed Income

3%

February 2007

Long/Short Equities

52%

Macro5%

Multi-strategy13%

Others2%

Relative Value4%

Arbitrage4%

CTA/Managed Futures

6%

Distressed Debt1% Event Driven

8% Fixed Income5%

February 2011

Changes in the strategic mix of Asian hedge funds by assets under management

Source: Eurekahedge

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Asian Hedge funds Winners & Losers

United Kingdom

21%

Hong kong17%

United States15%

Australia12%

Singapore10%

Japan6%

France4%

Switzerland2%

Luxembourg1%

Channel Islands

1%

Others11%

February 2007

United Kingdom

22%

Hong kong22%

United States14%

Australia10%

Singapore9%

Japan5%

France4%

Switzerland2%

Luxembourg1%

Channel Islands

1%

Others10%

February 2011

36% UK & US 32% UK & US

Decline of Australia

Source: Eurekahedge

Head office location by numbers of funds

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Asian Hedge funds Winners & LosersAsian hedge fund fees by launch year Market share of top Asian hedge fund prime brokers by

assets under management

Not weighted by capital – large launches charge fees

Source: Eurekahedge

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Foreign vs Local

• Soros• Viking• Moore Capital• GLG• Fortress

• Asian sleeves of Global portfolios• Are they here to stay this time?• Are opportunities better than those at home?

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Foreign vs Local

• 2010 – Nick Taylor, Senrigan– $200m seed, $1bn today

• 2010 – John ho, Janchor– No seed, $750m today

• 2011 – Morgan Tse, Azentus– GS spin out $1bn start up

• To come: – Nomura Prop Desk– Highbridge spin out

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Developments in Asian HF regulation

• 2010 – short selling reporting requirements tightened – Hong Kong

• 2010, October – Sales of securities to professional investors tightened –Hong Kong (most fund managers unaware)

• Ongoing lobbying by AIMA of FSTB for corporate law and tax changes to make HK a fund domicile (HKIMA against this initiative)

• Singapore 2011, tightening of regulations concerning authorisation of fund managers

• Korea – fund of funds to be allowed domestically (maybe….)

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Challenges Ahead

• Still a poorly capitalized industry

• Selling the dream – 90% of staff should get a proper job

• Flows coming from institutions

• Back to the future – Gentlemen's club, institutional platforms

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Challenges Ahead

• Collision of two worlds

• Short selling in retail products will come

• ETFs are dangerous

• Hedge Funds to become alternatives again

• AIMA off in wrong direction

All pundits are wrong

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