In writing about the China Investment Corporation (http://simonkerrhfblog.blogspot.com/2010/07/china-investment-corporationthe-next_07.html I wrote about York Capital Managment being the latest hedge fund to receive their capital. The article has been augmented twice, one of the changes being made today, with additional information on York Capital. The latest addition strongly reinforces the CIC decision.
The Year-to-Date return for the flagship York Investment Fund was 2.77% through the end of September.
Showing posts with label China. Show all posts
Showing posts with label China. Show all posts
Friday, 10 September 2010
Wednesday, 7 July 2010
China Investment Corporation…the next winner is…York Capital
China Investment Corporation (CIC), the Chinese sovereign wealth fund, currently manages $332bn andlast year invested $58bn. It has been on accelerated path in learning about investing in hedge funds for the last three years. A source close to the CIC suggests that they are about to make their next commitment to a specific hedge fund.
The story of China Investment Corporation’s interest in alternatives can be traced back to the purchase of a USD 3 billion stake in alternative investment company Blackstone during its IPO in mid-2007. A predecessor entity to the then unformed CIC negotiated a non-voting stake with a four year lock-up. On day one of public trading this looked like a master stroke as Blackrock stock soared to $45 from the $31 (top-of-the-range) issue price. However that level has never been seen since and post-Credit Crunch the BX stock traded down to $4 and is now at just over $9.
The second leg of the advisory platform for CIC’s hedge fund program was the purchase of an interest in Morgan Stanley late in 2007. The Chinese SWF bought $5.6 billion of Morgan Stanley convertible securities with a conversion price of $48 to $57 in 2007. This was a 10% stake at the time. The CIC’s stake in MS was then diluted when, in October 2008, a major stake in the investment bank was bought by Mitsubishi UFJ. In the middle of last year CIC spent $1.2bn buying 44.7m shares of common stock in the bulge bracket investment firm to take its interest back to 9.86%.
So the CIC had two natural partners in looking to expand its investments beyond fixed interest and other additional assets. The intention from the off was to invest as much as $6bn within a year to hedge funds. The first step for CIC in investing in hedge funds was taken in July 2009 when allocations were made to the fund of hedge fund units of Blackrock and Morgan Stanley. Blackrock received an allocation of $500m to put into a portfolio of hedge funds, and Morgan Stanley some $200m.
Co-Opted Specialist Knowledge
At this point, at the start of the second half of 2009, the China Investment Corporation was utilising a knowledgeable special adviser to the chief investment officer of CIC. Felix Chee, the special advisor, had been responsible for an allocation of $1bn to hedge funds when he was working at the endowment of the University of Toronto. But this was several leagues different. The intention then and now is to build a core exposure to hedge funds for CIC with two elements – holdings in large, experienced single manager hedge funds and exposure to hedge funds via a small number of funds of hedge funds.
So having described the first funds of hedge funds exposures, what about the single manager exposures? Special advisor Chee has stated that CIC were to going to give capital to the best managers across a spectrum of investment strategies. The representatives of the Chinese SWF certainly started at the top: they invited Jim Simons of Renaissance Technologies to go to China to see if he was prepared to sell a chunk of his firm. He was not, and given his subsequent announcement that Simons will retire this year, it was only to be expected that the first single manager allocations went elsewhere. The first allocations came at the end of the 3Q last year and went to a natural extension of the fixed income investments already in place within the CIC, probably allowing some comfort that the strategies being used were ones that could be readily understood.
Unsurprisingly, the first two allocations of capital went to large, successful hedge fund management companies. The largest mandate to date has gone to a very large firm - Oaktree Capital Management is a Los Angeles based shop that manages US$76 billion in fixed-income strategies including distressed debt and high yield. The CIC has given Oaktree a $1bn mandate.
Oaktree espouses a clear investment philosophy based on six elements: the primacy of risk control (priority of preventing losses); an emphasis on consistent returns in the medium term to deliver a high batting average in the long term; Oaktree only invests in inefficient markets which may give a return to the manager’s skill and effort; specialisation of each investment portfolio is the surest route to the return targets; the investment process is entirely bottom up; the firm keep portfolios fully invested whenever attractively priced assets can be bought and do not time markets.
The second single manager hedge fund mandate granted by the China Investment Corporation was awarded at the end of last September to London’s Capula Investment Management. Reflecting the dynamism of the industry, Capula was set up only in 2005, and sold a chunk of the equity in the management company to the Petershill Fund (run by Goldman Sachs) in 2008. At the time of the capital allocation from CIC Capula ran between $3 ½ and 4 bn mostly in fixed income arbitrage. Capula presently advises on $4.6bn of assets. The returns of the main fund, Capula Global Relative Value Fund are very impressive – average annual returns of 13.3% with 88% of months positive. The volatility of the return series is only just under 3.5% and there has been no correlation to traded equity markets.
In-House Specialist Knowledge
After the first single manager hedge fund investments in the third quarter of 2009, the next significant development in the hedge fund activities of CIC came at the end of the year when there was an appointment to run the hedge fund investments on a permanent basis. Bill Lu, was born and educated in China, but received his post graduate education in the United States, and went on to manage the relationships in China of Paul Tudor Jones’ Tudor Investments. His background as a portfolio manager at Tudor, and experience at both end of the Sino-American axis make his credentials clear.
Lu is responsible for CIC’s investments in hedge funds and investments in securities which reflect hedge fund exposures in public markets. It is thought that after a couple of quarters bedding in, the first of Bill Lu’s major decisions is about to become publicly visible as the next single manager hedge fund mandate from CIC is made known.
The market scuttlebutt suggests that CIC will allocate capital to New York’s York Capital, an organisation running nearly $14bn in event driven strategies. James Dinan’s firm is known for using a catalyst-driven, fundamental value approach, which it applies to US, European and Asian developed market securities, including taking credit risk. Whilst the size of the allocation has not been confirmed, an allocation of $500bn would be proportionate to the other hedge fund investments of China Investment Corporation.
Two Additions from AR Magazine: 1) York Capital Ranked Number One Among Top 50 by Investors
2)York explains May losses
RANKED Number 1 in 2010
AR Magazine carries out an annual poll in which investors score hedge funds by various criteria. In 2010 York Capital Management came top, moving up from 10th place last year. Here is what the citation says:
"York Capital, with $11.35 billion, edged $50.9 billion Bridgewater Associates out of the lead, scoring 52.63 points out of a possible 60 and jumping nine notches from its tenth-place ranking in last year's survey. "I think the world of York's founder [Jamie Dinan] in terms of his ability and his integrity, and needless to say, I am impressed with his performance," says Richard Galanti, chief financial officer of Costco, who has been an investor in York since its inception. Adds another institutional investor in the firm: "They were very bearish at the end of '08, but then they were very adaptable when they realized that things had changed in '09... when they realized equities weren't going to be as bad as they thought, they were able to make that adjustment and to make something off of it, which is very admirable."
Investors say their main concern now with hedge fund generally is performance, as evidenced by alpha generation jumping into second place of the six factors that investors took into consideration when scoring the top 50 firms in the AR Billion Dollar Club for the report card. York, which did not restrict redemptions during 2008—which investors appear to remember—also ranked high in transparency and liquidity, two of the other six factors. Investors rated firms on alignment of interests, alpha generation, independent oversight, infrastructure, transparency and liquidity terms, scoring firms in each of those categories on a scale from 1 to 10, for the possible total of 60.
MAY LOSSES
York Capital Management’s investments in General Motors, Alcon and Xerox contributed to the York Select Fund’s negative May performance, according to a recent investor letter. The $1.2 billion fund’s private equity position in Chrysler, meanwhile, produced positive returns. York Select, a concentrated event-driven strategy, dropped 5.70% in May, but remains up 1.23% for the year.
"In May, the equity and credit markets dramatically shifted their focus from corporate earnings growth to the unfolding European fiscal crisis and the potential impact on the global recovery,” read the letter. “These macro economic concerns triggered significant market selling and investor de-risking activities overshadowing positive company-specific developments.”
York manages $13.8 billion firmwide. Chief investment officer Daniel Schwartz and partner Michael Weinberger co-manage York Select in New York.
York Select is a more concentrated version of the firm’s flagship $4.3 billion multistrategy and diversified event-driven fund, York Capital Management, which fell 4.9% in May leaving it up 3 basis points for the year. In 2009, York Select gained 82.59%, following a loss of 44.91% in 2008. Most of the Select fund’s investors are wealthy individuals and family offices. The fund is not open to institutions given its concentrated positions and high volatility.
In May, the majority of the York Select fund was heavily invested in financials (37.5% of the portfolio), materials (28%), and healthcare (14.6%).
York Select’s position in General Motors contributed to a month in the red. “Our bonds in General Motors produced losses on concerns about the sustainability of the economic recovery following the events in Europe,” the letter read.
Another losing position was the fund’s investment in eye-care company Alcon. In January, Nestlé agreed to sell its remaining interest of 156,076,263 shares of Alcon to healthcare company Novartis. But the remaining shares of Alcon have declined recently due to Novartis’ shares trading poorly and the Swiss Franc’s fall against the U.S. dollar, the letter said. York believes that Novartis will need to increase its offer in order to encourage the minority Alcon shareholders to tender their shares, given that Novartis’ offer to Nestlé is higher than the stock consideration offered to Alcon shareholders.
York’s stake in European polyethylene-maker Lyondell Chemical Company also dipped due to the general market weakness in European equities. Prior gains in Xerox likewise evaporated in the May maelstrom.
Positive positions came from the Select fund’s private equity investment in Chrysler. “After the U.S. government stake was bought out, [it] resulted in increased investor interest."
York remains concerned about the European sovereign debt situation and its effect on the global economy. “We are focused on identifying the compelling opportunities that market dislocations often offer our strategies."
All of York's funds were negative in May; The $3.4 billion York Credit Opportunities Fund dropped 4.80%; the $260 million York Global Value Partners fund fell 6.20%; the $2.3 billion York European Opportunities Fund fell 2%; the $420 million York European Focus Fund was down 3.50%; the $210 million York Asian Opportunities Fund dropped 5.70% and the York Total Return fund, the firm’s fund of funds that invests across all of its funds, was down 4.60%.
Most of York’s funds remain positive for the year. The Credit fund was up 4.48%, Global Value was up 65 basis points, European was up 5.18%, European Focus was up 3.67%, and Total Return was up 2.39%. The only fund in the red for the year is the Asian fund, with a loss of 1.07%.
The story of China Investment Corporation’s interest in alternatives can be traced back to the purchase of a USD 3 billion stake in alternative investment company Blackstone during its IPO in mid-2007. A predecessor entity to the then unformed CIC negotiated a non-voting stake with a four year lock-up. On day one of public trading this looked like a master stroke as Blackrock stock soared to $45 from the $31 (top-of-the-range) issue price. However that level has never been seen since and post-Credit Crunch the BX stock traded down to $4 and is now at just over $9.
The second leg of the advisory platform for CIC’s hedge fund program was the purchase of an interest in Morgan Stanley late in 2007. The Chinese SWF bought $5.6 billion of Morgan Stanley convertible securities with a conversion price of $48 to $57 in 2007. This was a 10% stake at the time. The CIC’s stake in MS was then diluted when, in October 2008, a major stake in the investment bank was bought by Mitsubishi UFJ. In the middle of last year CIC spent $1.2bn buying 44.7m shares of common stock in the bulge bracket investment firm to take its interest back to 9.86%.
So the CIC had two natural partners in looking to expand its investments beyond fixed interest and other additional assets. The intention from the off was to invest as much as $6bn within a year to hedge funds. The first step for CIC in investing in hedge funds was taken in July 2009 when allocations were made to the fund of hedge fund units of Blackrock and Morgan Stanley. Blackrock received an allocation of $500m to put into a portfolio of hedge funds, and Morgan Stanley some $200m.
Co-Opted Specialist Knowledge
At this point, at the start of the second half of 2009, the China Investment Corporation was utilising a knowledgeable special adviser to the chief investment officer of CIC. Felix Chee, the special advisor, had been responsible for an allocation of $1bn to hedge funds when he was working at the endowment of the University of Toronto. But this was several leagues different. The intention then and now is to build a core exposure to hedge funds for CIC with two elements – holdings in large, experienced single manager hedge funds and exposure to hedge funds via a small number of funds of hedge funds.
So having described the first funds of hedge funds exposures, what about the single manager exposures? Special advisor Chee has stated that CIC were to going to give capital to the best managers across a spectrum of investment strategies. The representatives of the Chinese SWF certainly started at the top: they invited Jim Simons of Renaissance Technologies to go to China to see if he was prepared to sell a chunk of his firm. He was not, and given his subsequent announcement that Simons will retire this year, it was only to be expected that the first single manager allocations went elsewhere. The first allocations came at the end of the 3Q last year and went to a natural extension of the fixed income investments already in place within the CIC, probably allowing some comfort that the strategies being used were ones that could be readily understood.
Unsurprisingly, the first two allocations of capital went to large, successful hedge fund management companies. The largest mandate to date has gone to a very large firm - Oaktree Capital Management is a Los Angeles based shop that manages US$76 billion in fixed-income strategies including distressed debt and high yield. The CIC has given Oaktree a $1bn mandate.
Oaktree espouses a clear investment philosophy based on six elements: the primacy of risk control (priority of preventing losses); an emphasis on consistent returns in the medium term to deliver a high batting average in the long term; Oaktree only invests in inefficient markets which may give a return to the manager’s skill and effort; specialisation of each investment portfolio is the surest route to the return targets; the investment process is entirely bottom up; the firm keep portfolios fully invested whenever attractively priced assets can be bought and do not time markets.
The second single manager hedge fund mandate granted by the China Investment Corporation was awarded at the end of last September to London’s Capula Investment Management. Reflecting the dynamism of the industry, Capula was set up only in 2005, and sold a chunk of the equity in the management company to the Petershill Fund (run by Goldman Sachs) in 2008. At the time of the capital allocation from CIC Capula ran between $3 ½ and 4 bn mostly in fixed income arbitrage. Capula presently advises on $4.6bn of assets. The returns of the main fund, Capula Global Relative Value Fund are very impressive – average annual returns of 13.3% with 88% of months positive. The volatility of the return series is only just under 3.5% and there has been no correlation to traded equity markets.
In-House Specialist Knowledge
After the first single manager hedge fund investments in the third quarter of 2009, the next significant development in the hedge fund activities of CIC came at the end of the year when there was an appointment to run the hedge fund investments on a permanent basis. Bill Lu, was born and educated in China, but received his post graduate education in the United States, and went on to manage the relationships in China of Paul Tudor Jones’ Tudor Investments. His background as a portfolio manager at Tudor, and experience at both end of the Sino-American axis make his credentials clear.
Lu is responsible for CIC’s investments in hedge funds and investments in securities which reflect hedge fund exposures in public markets. It is thought that after a couple of quarters bedding in, the first of Bill Lu’s major decisions is about to become publicly visible as the next single manager hedge fund mandate from CIC is made known.
The market scuttlebutt suggests that CIC will allocate capital to New York’s York Capital, an organisation running nearly $14bn in event driven strategies. James Dinan’s firm is known for using a catalyst-driven, fundamental value approach, which it applies to US, European and Asian developed market securities, including taking credit risk. Whilst the size of the allocation has not been confirmed, an allocation of $500bn would be proportionate to the other hedge fund investments of China Investment Corporation.
Two Additions from AR Magazine: 1) York Capital Ranked Number One Among Top 50 by Investors
2)York explains May losses
RANKED Number 1 in 2010
AR Magazine carries out an annual poll in which investors score hedge funds by various criteria. In 2010 York Capital Management came top, moving up from 10th place last year. Here is what the citation says:
"York Capital, with $11.35 billion, edged $50.9 billion Bridgewater Associates out of the lead, scoring 52.63 points out of a possible 60 and jumping nine notches from its tenth-place ranking in last year's survey. "I think the world of York's founder [Jamie Dinan] in terms of his ability and his integrity, and needless to say, I am impressed with his performance," says Richard Galanti, chief financial officer of Costco, who has been an investor in York since its inception. Adds another institutional investor in the firm: "They were very bearish at the end of '08, but then they were very adaptable when they realized that things had changed in '09... when they realized equities weren't going to be as bad as they thought, they were able to make that adjustment and to make something off of it, which is very admirable."
Investors say their main concern now with hedge fund generally is performance, as evidenced by alpha generation jumping into second place of the six factors that investors took into consideration when scoring the top 50 firms in the AR Billion Dollar Club for the report card. York, which did not restrict redemptions during 2008—which investors appear to remember—also ranked high in transparency and liquidity, two of the other six factors. Investors rated firms on alignment of interests, alpha generation, independent oversight, infrastructure, transparency and liquidity terms, scoring firms in each of those categories on a scale from 1 to 10, for the possible total of 60.
MAY LOSSES
York Capital Management’s investments in General Motors, Alcon and Xerox contributed to the York Select Fund’s negative May performance, according to a recent investor letter. The $1.2 billion fund’s private equity position in Chrysler, meanwhile, produced positive returns. York Select, a concentrated event-driven strategy, dropped 5.70% in May, but remains up 1.23% for the year.
"In May, the equity and credit markets dramatically shifted their focus from corporate earnings growth to the unfolding European fiscal crisis and the potential impact on the global recovery,” read the letter. “These macro economic concerns triggered significant market selling and investor de-risking activities overshadowing positive company-specific developments.”
York manages $13.8 billion firmwide. Chief investment officer Daniel Schwartz and partner Michael Weinberger co-manage York Select in New York.
York Select is a more concentrated version of the firm’s flagship $4.3 billion multistrategy and diversified event-driven fund, York Capital Management, which fell 4.9% in May leaving it up 3 basis points for the year. In 2009, York Select gained 82.59%, following a loss of 44.91% in 2008. Most of the Select fund’s investors are wealthy individuals and family offices. The fund is not open to institutions given its concentrated positions and high volatility.
In May, the majority of the York Select fund was heavily invested in financials (37.5% of the portfolio), materials (28%), and healthcare (14.6%).
York Select’s position in General Motors contributed to a month in the red. “Our bonds in General Motors produced losses on concerns about the sustainability of the economic recovery following the events in Europe,” the letter read.
Another losing position was the fund’s investment in eye-care company Alcon. In January, Nestlé agreed to sell its remaining interest of 156,076,263 shares of Alcon to healthcare company Novartis. But the remaining shares of Alcon have declined recently due to Novartis’ shares trading poorly and the Swiss Franc’s fall against the U.S. dollar, the letter said. York believes that Novartis will need to increase its offer in order to encourage the minority Alcon shareholders to tender their shares, given that Novartis’ offer to Nestlé is higher than the stock consideration offered to Alcon shareholders.
York’s stake in European polyethylene-maker Lyondell Chemical Company also dipped due to the general market weakness in European equities. Prior gains in Xerox likewise evaporated in the May maelstrom.
Positive positions came from the Select fund’s private equity investment in Chrysler. “After the U.S. government stake was bought out, [it] resulted in increased investor interest."
York remains concerned about the European sovereign debt situation and its effect on the global economy. “We are focused on identifying the compelling opportunities that market dislocations often offer our strategies."
All of York's funds were negative in May; The $3.4 billion York Credit Opportunities Fund dropped 4.80%; the $260 million York Global Value Partners fund fell 6.20%; the $2.3 billion York European Opportunities Fund fell 2%; the $420 million York European Focus Fund was down 3.50%; the $210 million York Asian Opportunities Fund dropped 5.70% and the York Total Return fund, the firm’s fund of funds that invests across all of its funds, was down 4.60%.
Most of York’s funds remain positive for the year. The Credit fund was up 4.48%, Global Value was up 65 basis points, European was up 5.18%, European Focus was up 3.67%, and Total Return was up 2.39%. The only fund in the red for the year is the Asian fund, with a loss of 1.07%.
Monday, 24 May 2010
Chart of The Week - Increasing Significance of Chinese Growth
I haven’t posted a chart of the week for some months. It has to be very telling; it has to be important.
This graphic qualifies on both counts:
Monthly change since January in real retail sales (in January 2007, US$ bn)
Source: Goldman Sachs Global ECS Research
What does it show? Over the period of the recent downturn in global economies, the loss of US real retail sales through recession was about the same in absolute Dollars as the gain in retail sales in absolute Dollars in China.
If ever there was a way of capturing the increased global significance of Chinese economic growth this is it. Chinese growth is so large that it rivals in absolute dollars the significance of the United States in changes in marginal contributions to real global growth, at least as far as the consumer is concerned.
Of course we already had on board that China’s growth in commodity consumption can overwhelm the significance of that of the rest of the world. But it is not just through industrialisation that China is making it’s impact.
Sunday, 11 April 2010
Returns from Special Situations to Become Special Again?
A few months ago I was a guest on the hedge fund radio show "The Naked Short Club" on Resonance FM. A question for the panel was "which hedge fund strategies did we each prefer this year?" My choice then and now are the event-driven strategies. I chose those strategies partly because the evidence of surveys of investors have not mentioned event-driven as a favourite (except for distressed), and on the basis of the market environment I see unfolding this year. Distressed securities funds posted the biggest inflow as a percentage of AUM in February this year (at 4.2% of assets) according to TrimTabs Investment Research and BarclayHedge - so they are hardly being ignored.
It still remains the case that investors compiling survey responses cite what has done well for the last six months, but what has changed over a shorter time-frame is the outlook for the special situations component of the event driven set of strategies. At the turn of the year it was somewhat fanciful to suggest that the market environment would be suitable for special sits investors - up to that point corporate activity was very limited in publicly traded markets. From a UK perspective we had a clear landmark takeover in the acquisition of Cadbury's by Kraft Inc, but other forms of M&A activity have taken place and there is activity in sectors beyond those that are consumer-related. The stock markets have reached recovery highs, retracing all of the fall from the second week of January into mid February. This has revived the animal spirits that drive markets, and primary and secondary issuance has picked up and will increase from here.
IPOs Spin-outs and Buy-ins as well as Takeovers
The issuance will be for a range of purposes- IPOs, spin-outs, and buy-ins as well as takeovers. IPOs that were scheduled to take place in February and were postponed will now be back under active consideration. The recovery in valuations in markets will encourage managements to listen to the sum-of-the-parts arguments and enhance shareholder value through spin-outs like that of Enquest from Petrofac. Just last week there was an example of a buy-in, as Agnico-Eagle Mines stepped up to the plate and elected to offer to acquire all the shares it does not already own in Comaplex Minerals.
M&A is back in the revived energy sector, and will come back in other resource-based sectors. The Chinese have stated their desire to acquire strategic resources on a global basis, and their activities will spark the attention of other acquirers on a game theory basis. In upstream energy in 2009 alone, China spent $16 billion gaining footprints in Canadian oil sands, the Gulf of Mexico, Nigeria, Gabon, Trinidad and Tobago, Ecuador, Syria, Iraq, Iran, Indonesia and Kazakhstan. There are expected to be more National Oil Company acquisitions this year in unconventional oil and gas production primarily sourced from gas shales, tight gas sands and oil sands according to industry consultants. Energy M&A will not be confined to NOCs and producing assets as shown by the acquisition of Smith International by Schlumberger.
In mining the secondary and tertiary stocks amongst the miners and mineral exploration stocks have started to out-perform the global major mining stocks as interest warms up. Before Easter there was corporate activity in gold (Newcrest's proposal to merge with Lihir Gold) and in the coal sector, and further deals in zinc.
Not Just Resources
He continued, "We have seen a large number of deals where the average premium over the market price has been approximately 40%. When Air Products (APD, Fortune 500) bids $5 billion in cash for AirGas (ARG), which is 38% over market price, Air Products is telling us they feel sufficiently comfortable about their own business that they are willing to take on a lot of debt to do the deal. It's the same thing with Merck AG's $7 billion offer to buy Millipore (MIL) and Simon Property's (SPG) $10 billion bid to acquire General Growth Properties (GGP). When you buy a share in a business, you're buying a share of its brick, mortar, machinery, and earning power. What corporations are saying is that the equity market is not overvalued."
The corporate buyer has not been absent from the market, but should be more evident in the rest of this year. The pressures resulting from the "shareholder value" mantra is still there, and the continuing recovery of the banking sector will allow some debt financing this year, which was largely absent last year. For similar reasons it would not come as a surprise to see more activity by private equity in the second half of the year, both disposals and acquisitions. This combination of factors will present an increasingly rich environment for managers of special situations capital, both on a dedicated basis and as part of a multi-strategy offering. Better returns will result for special sits strategies.
*The article won't link directly but can be found at http://money.cnn.com/, using search term "Leon Cooperman"
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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.
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.
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.
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.”
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.
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.
”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.
“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.
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.
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 clichés 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
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 clichés 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
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