Tuesday, 23 February 2010

Insight into European Hedge Funds from FSA Report

The FSA’s report, ‘Assessing possible sources of systemic risk from hedge funds’ was released today and is available from the FSA at http://www.fsa.gov.uk/pubs/other/hedge_funds.pdf. It offers some insights into leverage, margining, liquidity and the distribution of fund returns of the largest funds under the FSA's jurisdiction. The FSA regulates over three-quarters of Europe's hedge fund industry, so this is an insight into the whole of the European industry, by proxy.


Gross Exposure of London's 50 Largest Hedge Funds in October 2009




















  • There is a pronounced phenomena that fixed income funds (including credit L/S) need a larger gross to deliver alpha. Multi-strat funds typically have a fixed income sub-strategy. 
  • Global macro funds weren't particulalrly levered in October last year - maybe they were largely out of bonds? 
  • Interestingly, the classicly leveraged strategy of managed futures is unlevered according to the FSA's survey results.
  • London's L/S equity funds had a smaller gross than their US counterparts in October.


Fund and Portfolio Liquidity of London's 50 Largest Hedge Funds

























Average Margin Requirements for London's 50 Largest Hedge Funds






















  • These are first tier hedge fund management companies, so would not suffer first from changes to margining rules by prime brokers. So the stability of margin requirements shown in October 2008 is perhaps understandable for them alone. That the margin requirements went up subsequently even for the top tier hedge funds shows the (lack of) availability of credit in 2009.


Distribution of Fund Returns of London's 50 Largest Hedge Funds in 6 Months to Oct 2009














  • As much as anything else it is impressive how much the distribution of returns across the largest funds in the six months to October 2009 conforms to a (long) option-like payoff profile. Curtailing the downside and top-draw risk management is what investors in first tier funds expect and should get.


Change in Fund AUM of London's 50 Largest Hedge Funds over Six Months to October 2009













  • All funds sufferred redemptions in the first half of 2009. The biggest and best funds had inflows in the second half of the year, but some London-based managers such as Lansdowne had excellent investment perfromance too. Those that performed well in 2009 had inflows and returns contributing to the growth in AUM.



Fund Total Number of Positions of London's 50 Largest Hedge Funds














  • A few of the largest hedge funds in London have less than 50 positions in total.
  • Most of the largest hedge funds managed from London, or where the fund management company if overseen by the FSA (like Moore Capital and Walter Capital, the SAC subsidiary), have 100-500 positions.
  • Some of the multi-strategy funds engaged in statistical arbitrage or high frequency trading run portfolios with more than 5,000 positions. To put this in context there are around 3,000 different companies traded on the London Stock Exchange (excluding AIM).





source of all graphics: FSA

Monday, 22 February 2010

LGT stays overweight macro traders

Thomas Weber, head of Hedge Fund Investment, LGT Capital Partners and lead portfolio manager of Castle Alternative Invest, commented on the fund’s performance of up 12.6% in 2009 (in NAV terms).
  • Significant allocation to CTA/macro strategies provides diversification from equities and bond
  • Move from systematic traders to global macro managers aided outperformance in 2008/09
  • Portfolio remains focused on flexible, liquid, less correlated strategies

Weber says: “In early 2009 we moved CTA/macro allocation away from systematic traders and increased exposure to global macro managers, which helped the company outperform the HFR Fund of Funds Index for the period from 1 January 2008 to 31 December 2009. We remain overweight discretionary macro and underweight systematic traders because, at present, markets are not subject to major dislocations, which have been the prime opportunity for systematic and short term traders. More benign market conditions enable macro managers to prosper over their shorter term, technical counterparts.”



Friday, 19 February 2010

From the GLG Earnings Release - Flows, High Water Marks and the Outlook for CB Arbitrage

From the Full Year Statements for GLG Partners Inc.

Noam Gottesman, Chairman and Co-CEO of GLG said : “Encouragingly, AUM flows at GLG have turned definitively positive over the past six months and looking forward, I am confident that GLG remains well-positioned to be a leading beneficiary as industry flows expand."

4Q net inflows of $723 million, mostly reflecting interest in GLG's alternative strategy managed accounts,. Net inflows in the 3Q (across long only and hedge) were $216m.



Conference Call Extracts on Flows, High Water Marks and the Outlook for CB Arbitrage


Noam Gottesman
“In fact, we are seeing growing interest in GLG from both existing and potential clients. Our organic net flows were positive again in the fourth quarter, after turning positive in the third quarter, following six months of stabilizing trends. Importantly, the redemption wave that crested late in 2008 now appears well behind us.

"Further, though the pacing and scale of this next cycle of inflows remain difficult to forecast, we believe it has definitely begun. It is notable that we gained several significant new client relationships in the quarter, including among others, a prominent sovereign wealth fund and a European Insurance company.

"At the end of the fourth quarter we had approximately $7.5 billion in AUM above water within 5% of high watermark, part of a potential 12.5 billion in performance fee eligible assets under management. We have another 0.8 billion in AUM within five to 10% of the respective high watermark.

"I'm strongly encouraged by the flows we have seen during the second half of 2009 and in the early weeks of 2010."



Jeff Rojek, CFO

At the end of December, we had roughly 7.5 billion out of a possible 12.5 billion of performance fee eligible AUM, above or within 5% of their respective high watermarks. These numbers include AUM, special asset vehicles and other liquidating strategies.

Broken down by strategy, approximately 3.2 billion of our alternative AUM, 0.9 billion of our long-only AUM, and 1.7 billion of our 130/30 strategies or similar AUM is above water. Also, approximately, 0.4 billion of our alternative AUM, 0.2 billion of our long-only AUM, and 1.1 billion of our 130/30 strategies or similar AUM is within 5% or less of their respective high watermarks.

Of the remaining five billion of AUM under water, 1.8 billion is in alternative strategies and 3.2 billion is in our long-only strategy. Briefly again even further 0.4 billion of alternative AUM and 0.4 billion of long-only AUM is between five and 10% of their respective high water marks. 0.8 billion of alternative AUM and 1.7 billion of long-only AUM between ten and 30% of their high water marks. While 0.7 billion of alternative AUM and as 1 billion of long-only AUM is more than 30% below the high water marks.



Q&As


(A - Noam Gottesman, Chairman and Co-Chief Executive Officer): We're very encouraged by what we're seeing in the pipeline. The inflow cycle as we mentioned, it's hard to sort of guage the pacing, the magnitude but we're actually seeing it pretty much across the board, definitely seeing a lot of alternative interest now, and whereas in the previous few months, there were some alternative but mainly traditional. But we are - we're seeing very strong flows into the Long-Short products, we're seeing strong flows into emerging market. And convertible, we're seeing very good interest in the UCITS III product,

...A large part of the 4Q flows were from sovereign investors in long only mandates.


A - Noam Gottesman, Chairman and Co-Chief Executive Officer): Yes, generally, I think, people are definitely allocating. There is no question. There is certainly an awful lot of interest, and I think they're not doing it because they're bored. I think they've got money to put to work, and alternatives definitely delivered. And I think the prospects are looking bright for the industry right now.



(Q - Roger Freeman): Are you finding that you're coming in as a result of manager substitution or are you coming in as an additional manager?

(A - Noam Gottesman, Chairman and Co-Chief Executive Officer): I think it's both. I think the people sat on their hands for much of last year. They redeemed in some places, but they sat on their hands. They're just - I'm not really seeing - it's hard for me to gauge where it's coming from, but it's definitely coming.

… The alternative assets continued to be at full alternative fees, we are not seeing any real pricing pressure there.



(Q - Roger Freeman): What are your thoughts on the convert market outlook? I think, you mentioned there was strong interest in the fourth quarter. Issuance seems to have been light so far this year relative to what people were expecting. Do you see a lot of issuance coming down the pike, and is that a key to driving returns and flows in that area?

(A - Noam Gottesman, Chairman and Co-Chief Executive Officer): I think we're still very positive on the convertible market and we were for - we have been, as you know. And it’s a market that's done exceptionally well. Our convertible funds - our convertible arbitrage funds - have continued to perform very strongly, including in January where the convertible arbitrage fund, I think, was up close to 9%.

We think issuance will continue. And we think that new deals are going to have to come cheap, and I think it's going to provide opportunities. And the volatility in the market should be very beneficial. So we do continue to feel strongly positive on it. We also believe that there would be a large M&A flow that continues, which will also drive new issuance.

GLG Global Convertible Fund versus Bloomberg Active Convertible Index

Thursday, 11 February 2010

Industry Flows – Inference From Och Ziff Results Announced Today

Och-Ziff Capital Management Group LLC is a quoted company (Ticker:OZM), and as such we may get some insight into industry flows from their disclosures.


For sure, Och-Ziff is only truly representative of hedge fund management companies of its size, tenure, quality, and track record. In each of these regards OZM stands out. It is emblematic of the track record of Och-Ziff that, since the inception of the flagship fund, the Och-Ziff Master Fund has returned 14.5% compound (net of fees) to investors, which equates to a Sharpe ratio of 1.83.




Source: Och-Ziff Capital Management Group LLC

Och Ziff funds, like 60% of all hedge funds, hit new high-water marks in 2009. That, and by inference the returns achieved in 2009, and the size and quality of operations of Och-Ziff Capital Management drew in a disproportionate amount of industry flows last year. The big got bigger as a proportion of hedge fund industry assets in 2009 – this was not just a flight-to-safety argument, but every hedge fund in the world had capacity for new capital in the first half of last year as redemptions given in late 2008 came into full effect. So the biggest and best benefitted particularly because many of the hedge funds in that subset of funds had been hard closed to all investors for some time. Why not invest with Tudor, Moore and Och-Ziff if you can?


• Och-Ziff’s assets under management were $23.1 billion as of December 31, 2009, 4% higher than the $22.3 billion in assets under management as of September 30, 2009 but 14% lower than the $27.0 billion in assets under management as of December 31, 2008. The $3.9 billion year-over-year decrease was driven by net outflows of $8.1 billion, partially offset by performance-related appreciation of $4.2 billion during the year.


• During the 2009 fourth quarter, the $802 million increase in assets under management was driven by performance-related appreciation of approximately $497 million and net inflows of approximately $305 million.


• Assets under management as of January 1, 2010 were $23.5 billion, which reflected January 1, 2010 capital inflows (net of redemption requests received for December 31, 2009) of approximately $400 million.


• Estimated assets under management of $24.0 billion as of February 1, 2010, reflecting capital inflows of approximately $250 million and performance-related appreciation of approximately $250 million


The point to emphasise is that sequence of net investor flows for Och-Ziff went from $305m for the 4th quarter, to $400m for January 1st, to $250m for February 1st 2010.

Dan Och, Chairman and Chief Executive Officer of Och-Ziff, said “We believe that the capital inflow cycle for the hedge fund industry has begun, and that our assets under management will grow over time. Institutional investors remain extremely focused on manager selection, and we remain confident that our track record, infrastructure and demonstrated alignment of interests with our fund investors will continue to differentiate us in the marketplace.”

Dan Och’s statement about their own prospects of drawing investor flow might be true, but if Och-Ziff had smaller flows for February1st than those of January 1st, then the industry experience is likely to be significantly less positive for January and February flows.


HFN reported that there was a very small net outflow from the industry in December 2009, at a time when Och-Ziff was experiencing inflows. Och-Ziff inflows have moderated since. Does that mean that the industry has had further outflows in January?

Wednesday, 10 February 2010

Performance of Equity Hedge Funds versus Equity Markets This Year

Investors don't need investments in equity hedge funds on a multi-month basis when equity markets are in a multi-year bull market. At the margin equity hedge fund holdings would moderate a monthly return series of pure fully-invested equity market exposures. In prolonged bull phases equity hedge holdings would produce slightly lower losses in the down months, during the pauses that refresh in major bull markets. But equity hedge fund exposure will not produce positive absolute returns in down months of a prolonged bull. This is shown in the first graphic below.

The first graphic (courtesy of Bloomberg LLP) shows the price series and relative returns of HFR's Investible Equity Hedge Index and the S&P500. HFRXEH is a good proxy of US-based equity hedge managers, and has the distinct advantage for hedge fund watchers of being a daily return series. The top half of the graphic shows two line charts for the two indices. The green shaded part of the lower half of the first graphic shows the relative performance of equity hedge funds against the equity market. When the line in the lower half moves up equity hedge funds are out-performing equity markets, and vice versa.


So the lower half of the first graphic shows that equity hedge funds under-perfromed the multi-year equity bull market of 2003 to August 2007, then out-performed the equity market into the market low of March 2009.

The second graphic here tells the same story over the last 17 months. Simply put, equity hedge fund managers as a whole cannot match a market rally of 50%-plus from the low that turns on a dime.


Amongst the questions I want to address here is how have equity hedge funds done this year, and what should investors in equity hedge funds have expected, given the market conditions experienced.

Over the year-to-date (up to and including Monday the 8th of February) the HFR Equity Hedge Index has fallen 1.6%, and over that time the S&P has fallen 5.2%.  There have been two distinct phases for the equity market in the year to date period: stocks rallied 3.1% from the start of the year to the S&P high on the 19th of January, and then stocks fell 8.1% to the 8th of January. The high for the HFR hedge fund index came a week before the price peak of the S&P500: the inference being that equity hedge managers were already reigning back net equity market exposure as the market approached its peak. Further, the relative movements of the hedge fund index to the stock market index sugggest that in the first two weeks of the year equity hedge fund managers as an aggregate had a net market exposure of around 80%. From the stock market peak on the 19th of January to the 8th of February the decline in equity hedge fund NAVs suggests that the net exposure of equity hedge funds in America was just under 60%.

The returns from equity hedge funds this year will have come from both stock selection and net market beta, and at the index level it is not possible to break that down (ask your manager for details). The evidence from the year to date numbers so far is that equity hedge managers have reduced their net exposures going into the fall in stock prices and mitigated the losses of the capital of their investors through so doing.


Addendum: The BoA/Merrill Lynch Hedge Fund Monitor for 8th February estimated that (globally) equity long/short funds had cut market exposure to a net 27-28%  in the first week of February. If so that would be the lowest net exposure to markets since May of 2009.

Friday, 5 February 2010

Problems and Solutions in Investing with China-based Hedge Funds

This blog has been running for four months and this is the first posting to mention China. At the start of the year as strategists and economists gave outlooks for 2010 it was all about China. Anthony Bolton, after a career as a London-based fund manager at Fidelity dedicated to UK equities, has come out of retirement to run a Chinese equity fund and is to be based in Hong Kong. As a destination for investment, the popularity of China-focused funds is certainly on the rise. Sales of China-focused funds via Fidelity’s fund platform, FundsNetwork, increased by 59% in 2009, while sales into Fidelity’s China Focus Fund alone increased by 239%. That is how enticing China is as an investment destination. However, whilst  there has been a China theme to many investment portfolios, and the largest hedge fund companies have opened Hong Kong or mainland China offices, Chinese dedicated hedge funds have been something of a side show in the hedge fund industry. This reflects that China is much more developed as a manufacturing centre than a service and financial centre.

So China is recognised as  representing the largest global growth opportunity on a multi-year basis, but immature as far as the financial sector and capital markets are concerned. The Chinese equity markets represent a rich opportunity set, as do all frontier markets, but in this particular case, partly through cultural considerations, they can be difficult to access successfully and sustainably and with as much confidence in the execution as in the high concept. The practical difficulties were recently addressed by dedicated hedge fund site http://www.chinahedge.com.cn/, using comments by GFIA as a springboard.

The rest of this post is in two parts: the article from Chinahedge, which has been re-written but not changed in shape or substance, and in part two a full, considered response from London-based Fund of Funds manager Caliburn Capital Partners, which targeted exposure to the China theme some years ago, and which has supported exposure in the region through a Singapore office.

Part One - The Problems

The investability of mainland China based managers has become an issue, as reflected in the decision by Singapore-based research firm GFIA to stop covering and investing in hedge funds based in mainland China. It has largely shifted its coverage to western-trained managers based in Hong Kong. As an example of the issues investors face it cites that on a number of occasions China-based hedge funds would not reveal the identity of fund backers or the background of portfolio managers.



Compliance issues


The majority of offshore Chinese hedge funds are run from Hong Kong and the mainland China cities of Shanghai and Shenzhen, with very few in Beijing. For those with a Hong Kong office, almost all of them are Hong Kong Securities and Futures Commission-registered.


"At the very beginning of the due diligence process for investors allocating to China hedge funds investors should check to see if the investment manager is regulated, if the fund they manage have independent directors, if the fund is administered independently by a well known firm, and if the firm is audited independently by a top grade auditor." Andy Mantel, founder and CIO of Pacific Sun Investment Management (HK) Ltd, told China Hedge by phone. Andy is one of few offshore Greater China hedge fund managers who is non-Chinese but is fluent in Mandarin having been in the Greater China Region for about 20 years. “Basically all mainland headquartered hedge fund managers fail this initial due diligence test.”


Based on the statistics of China Hedge Fund Managers (Onshore) Database complied by China Hedge, most of the mainland managers (about 200 managers) are only managing local Chinese hedge funds denominated in RMB which are not accessible by global investors. Around 10% of them are running offshore Greater China hedge funds as well. Some have HKSFC-registered operation. Only a few of them have no HKSFC-registered operations which may cause some compliance issues.



Transparency and disclosure issue


GFIA mentioned in its report that those mainland-based managers show "a lack fundamental transparency and openness." It is an issue with some mainland-based fund managers that they are not willing to disclose their real holdings, and they do not have a disciplined risk management either, according to Kaikai Hua, director of a Shanghai-based wealth management company. He said, “normally they have a bet on one or two stocks or PE investments, and cover up the big loss or a liquidity problem until the stocks stop trading, or the IPO fails.”

Before selecting China managers for their US-based institutional clients, Bill Hunnicutt strictly required the Chinese managers must be willing to accept complete portfolio transparency which is now mandatory post-Madoff. Bill is the President of Hunnicutt & Co., LLC which is a placement agency based in the US. Bill said this means showing a current portfolio upon request. “Some larger US institutions require daily transparency via a dedicated website, while others will accept transparency via 3rd party vendors who then provide a general summary of the portfolio to the client.”



Business and cultural differences


There are clear cultural differences between local managers and global investors. Most local managers come from mainland mutual funds and securities firms. They are accustomed to running funds to a local standard, not those expected by global investors. “If the local managers do not tell you the companies they hold because they do not want others copy the idea. Knowing something early than the market is an important way for them to make money", Kaikai said.


The cultural differences may be exacerbated by communication problems. Most local managers are not comfortable to talk and write in English, so, the email reporting and newsletter that foreign investors in hedge funds expect may not be produced on a timely basis, if at all. “They would rather not say anything than express something badly. It takes a while for investors to fully communicate with these managers.” Kaikai said.


So local Chinese managers have something to learn in terms of the normal global practices and standards of running a hedge fund, as recognised by international investors. It has been suggested that mainland Chinese managers of hedge funds would benefit from getting together on a regular basis to share some thoughts of running a hedge fund business – a draft practice for participants would follow. Some managers recognize that there is a trend of increasing allocation to China-based managers, and in response they have recruited Chinese partners who are Western-educated and/or have worked for Western companies so that they can acquire that necessary knowledge about the standards expected by global investors.



Changing regulated status


The current Chinese law has regulated Chinese mutual funds, but these regulations do not apply to onshore Chinese hedge funds. According to MarketWatch published by Citi Securities and Investment Services dated 17 December 2009, the mutual fund law review workgroup, set up by the China Securities Regulatory Commission, has reached an agreement to include privately-raised funds as regulated mutual funds in the revised Mutual Fund Law.


Li, Zhenning, Chairman of Shanghai Rising Fund Management and the member of the mutual fund law review workgroup suggested that the regulator release licenses on privately-raised funds (commonly called local hedge funds) in the future. Investors, thus, can expect better regulation of local hedge funds in areas such as transparency issue and information disclosure.



Comparative advantage of Chinese-speaking CIOs


”Some local CIOs are sound managers. They know what they are doing, and what risk they face. Despite the lack of transparency and absence of rigid risk control systems, mainland-based managers have a big advantage in that they know the market well. They are more alert to the growth engines in the market, as well as problems in the companies. They spend more time talking to people in the street, and ask what they think of a product. It’s much easier for them to get access to companies too,” Kaikai said.



To combine both HK and mainland managers


“Hong Kong is by far the best place to manage a China fund. Aside from the unparalleled infrastructure and regulatory environment, the free flow of instant, uncensored information is vital when making investment decisions.” Andy Mantel said. “Research activities on the mainland can only add value if it is a supplementary research and information gathering office in support of the manager's headquarters,” Mantel emphasized.”


Kaikai Hua states that Western-trained managers based in Hong Kong have a different strategy. Most of their holdings are big names and liquid stocks. They perform better in a bear market or when market is in a correction. And they have a better understanding of tools for hedging. “We see that one side are stock pickers, and the others are portfolio manager.” Hua suggests that clients combine both, so that they can enjoy the advantages each offer in accessing the growth of Chinese market.



Chinese hedge funds are growing


There is a strong case to be made that the Chinese hedge fund sector is becoming more significant within the global hedge fund industry. Many institutional investors have started to monitor and even allocate to Chinese hedge funds in their global portfolios. “We should not neglect the China market” is the common belief of most global investors.


The booming equity market has helped the growth of industry assets. The industry recorded encouraging growth figures last year. Chinese onshore hedge fund managers launched 242 products in 2009, according to a report by Chengdu, Sichuan-based Sinolink Securities Co Ltd. The average size for every fund was about 90 million yuan ($13.2m), the report said. The 151 non-structured hedge funds returned 54% on average in 2009. As the end of 2009, the local China hedge fund industry reached around RMB 50 billion ($7.4bn). Zhang Jianhui, Director of Fund Research with Sinolink Securities, said at the Sinolink Hedge Fund Forum last Saturday in Beijing that the hedge fund industry of China would manage about RMB 100 billion as at the end of 2010.



Part Two - The Solutions


Thank you for giving us the opportunity to respond to Peter Douglas’s comments. Whilst we acknowledge that Peter is well respected in the industry and has a long track record as a specialist on the Asian hedge fund industry as a whole, we would take issue with his view that mainland based managers are not transparent enough for investors to assess them properly from a qualitative perspective.



For the sake of clarity, what we mean by “mainland based managers” are those where the Portfolio Manager is generally based in China, may or may not have a Western background or speak very good English, but will have a Hong Kong office (or other location outside the mainland) and will be registered with the SFC in Hong Kong (or equivalent in other jurisdictions). This group includes some of the most well known and longest established Greater China hedge funds and all of our comments below are based on this group of managers. (There is a second group of mainland based managers who don’t have an investment management company outside of the mainland but who offer offshore products. Caliburn does not invest in this second group of managers because the law is not clear if mainland based funds offering offshore funds should be classified as Permanent Establishments, which would mean the fund and firm would be subject to tax. Currently we are seeing the market leaders in China’s mainland fund management industry, who are in the process of launching offshore products, all setting up offices outside of the mainland in Hong Kong.)


Bearing in mind the definition above, we have built an extensive peer group of mainland based managers who we monitor and from whom we receive regular updates. In our view, some of the strongest Chinese research teams from both a bottom up and top down perspective are mainland based. Their research edge comes from their ability to pay significantly more than the established, large local mutual funds so they can hire the best research analysts. We also find that in these teams there are more analysts with direct industry as well as buy or sell side research experience which provides an additional research edge.


These managers generally provide monthly reporting which is of a high standard with good portfolio level data, and they are happy to speak about the portfolio composition and their market views in some detail. If there is a problem it may be that some of the larger managers ($300m AUM or above) may be reluctant to offer transparency to other than significant investors. Equally, bottom up stock pickers may be reticent to elaborate on their rationale for individual and current stock picks. However both of these observations can be made of hedge funds in general and are not particular to China. In general we do not encounter these difficulties with the majority of funds. Clearly, full transparency is always available through a managed account with most mainland based managers. Of course, just as in the Western hedge fund industry investors will again need to meet a certain minimum investment size to take advantage of this option.


Of the three mainland based managers with whom we are currently invested, one provides us with probably the greatest transparency of any manager that we follow, including providing the full portfolio twice a month and an enormous depth of insight directly from the CEO and senior investment team. From the remaining two we receive monthly portfolio information with very good transparency such that we are able to establish and monitor all of the key risks and sources of return of the funds.


There is no question that communication is not always easy with mainland based managers. There are often cultural and language difficulties to overcome and few are polished presenters. It is therefore important to have Mandarin speaking analysts but it is not just about language. For Caliburn as a thematic investor, research does not start with the manager; we do a lot of work to understand the underlying market and investment opportunity. This includes attendance at industry and corporate conferences as well as independent meetings with regional thought leaders. The natural result of these activities is that our research team is armed with a good understanding of the Chinese macroeconomic situation, policy news and sector news together with a general knowledge of stocks in key sectors. With this as background it is possible to establish a better relationship with managers. Our thematic work supports very specific and focused questioning and with this approach we have been very pleased with the level of disclosure we have received to date.


In relation to getting comfort with the risk management processes at these firms, as with all peer groups there are funds where we trust the risk management and there are funds where we remain cautious or sceptical. Without question a significant commitment of resources and time is required to regularly communicate with the funds and ask the right risk related questions to form a view. From an operational point of view, the mainland based funds that we have approved for investment have top tier independent 3rd party service providers (administrator, custodian, prime broker, and auditor) and in this respect reflect the best practices of their non-Asian counterparts.


In terms of performance in stress periods, broadly speaking most of the China based managers are bottom up investors and they did not protect the downside in 2008 as much as we would have hoped, though poor performance over this period is a common failing from across the hedge fund industry regardless of geography. We were pleased to see a number of managers sticking to a disciplined valuation approach which meant they were already running low exposure levels before the crisis unfolded. In general terms our invested China managers fared better in the second half of 2008 than in the first half of 2008 and China managers as a group performed much better than their BRIC peers over 2008 as a whole. Importantly, a number of China managers who lost 20% or more in 2008 subsequently made significant improvements to their risk management and their adherence to risk disciplines and this has served them well in months such as January 2010, during which they cut exposure and balanced their portfolio much more effectively than during the difficult Chinese markets of early 2008.


In conclusion, overall the standard clich├ęs apply: you get out what you put in. We commit significant time and resource to achieving a detailed understanding of each manager’s approach. We routinely make multiple trips to interview a manager in his / her office and follow up these on-site visits with a number of conference calls before deciding to bring a manager forward for discussion at our internal approval committee. There are barriers to entry and the investment opportunities may be less accessible as a consequence. However this can make the opportunities more interesting and the barriers can be overcome with a commitment of analytical time and a consistency of approach that reassures the manager that you are serious and there for the long term.

Richard Howard
Caliburn Capital Partners