Rupert Foster is the manager of one Asia-based equities strategy, the Matrix Asia Fund, that is now encapsulated as a UCITS fund on the Matrix platform, but which also exists as a Cayman Islands fund. We sat down with Rupert to talk about the challenges he sees as a fund manager with an Asia-based long/short equity portfolio looking to run money effectively in a UCITS format.
To start with, Matrix is trying to run its onshore book as closely as possible to its offshore fund. For the short side, it uses CFDs to take stock-specific short positions rather than borrowing in the physical market. The fund started dealing on a daily basis from March this year.
Matrix is keen to ensure that the UCITS fund does not become the dominant of the pair in terms of AUM, and wants the Cayman fund to remain at least twice the size of the UCITS, imposing a gate if needed. “If you do a lot of shorting in Asian stocks, you will never be a $1 billion plus fund,” Foster explains. “Our intention is to cap the Cayman fund at between five and six hundred [million].” This means the UCITS fund could end up at around €250 million before it closes.
This is a house policy with Matrix. “UCITS investors have the luxury of being able to run for the door intra-month, which offshore investors simply don’t have,” says Foster. “We don’t want the onshore fund to be in a position where it can disadvantage our offshore investors.”
A more liquid portfolio
From a liquidity perspective, Foster reckons that currently 5% of the portfolio would take more than three days to exit; the rest of the portfolio is more liquid. The offshore and onshore funds together cannot have more than 15% of their Net Asset Value in shares that will take more than five days to exit. Asia, he argues, is a lot more liquid to trade than it was back in the 1990s and the dark days of the Thai baht crisis. The fund has only made 5% of its total return from illiquid positions.
Foster freely accepts that, while his strategy can generate 15-20% per annum, the onshore fund could give up between 1% and 4% due to the restrictions imposed by UCITS. This liquidity premium, however, is something the UCITS investor will need to be prepared to pay, and Matrix is aware that counterparty risk is a big factor for this area of the hedge fund marketplace.
A comparison of the two funds’ performance finds the Cayman fund slightly ahead by around 20 basis points in January. But Foster believes investors will be happy to pay the difference: the Matrix Asia UCITS fund is seeing capital inflows, and Foster says he must be alive to the fact that this capital needs to be invested.
“Lots of UCITS investors [looking at hedge funds] are long-only investors who have become increasingly upset with the return profile of long-only managers,” Foster explains. “Hedge funds looked good when compared to the long-only funds during the downturn. Investors in long/short funds strategy can prove a nice partner to investment in a long-only strategy.”
Ultimately, investors in UCITS hedge funds are still looking to buy into solid, long-term investment performance, but while the primary bet or risk with the long-only manager is still the index, with hedge funds there are more ways to realise alpha. Foster says he has been able to realise 30% of his return from his short book, and points to this as a large advantage of the UCITS hedge fund over a conventional long-only Asia fund. “We have made money in a bullish environment,” he confirms, “we can play the beta too, but the majority is alpha. My fund is not a play on the markets per se, I’m not the best manager to do that with. Investors are also still tempted to benchmark funds against the index, but it makes hedge funds look good when the index goes down. The natural inclination is when the market is going up, to go long only.”
A brave, new Asia
At the time of our interview with Foster, Japan had yet to be struck by the 11th March earthquake and tsunami which devastated so much of Miyagi prefecture. But even so, many investors were in the process of exiting Asia (although still net buyers of Japanese stocks) as part of a general move out of emerging markets in February. “People are trying to market time Asia a lot these days, but it is very unlikely that they will market time correctly.”
The experience of Jabre Capital, which sustained a $300 million loss in an effort to time the Japanese market in the immediate aftermath of the earthquake is a salutary one.
“If [investors] are buying an Asia fund for market timing reasons, they are buying it for the wrong reasons,” Foster comments. “Many UCITS investors allocate to Asia on a long-only basis, but a hedge fund can be a useful balancing factor in a fund portfolio. My fund should be looked at as that balancing factor, a play on idiosyncrasies and irregularities. There is a lot of stuff going on in Asia: it is a great market to be invested in.”
Western investors were selling Asia in the first quarter of the year, particularly the ASEAN countries, India, and China. Yet there was net new investment travelling into Japan, Korea and Taiwan. “It feels like we have come to the end of a cycle,” says Foster, “but I don’t think it is over yet.”
Part of the reason that many investors chose to cut Asia allocations in Q1 was the fear that China’s economy was starting to over-heat, or that the Chinese would move too aggressively to stem inflation. Commenting on the tightening of monetary policy in China, Foster feels the authorities there have not been too savage. “They went over-loose in 2008, but the natural state for them is neutral. The Chinese monetary authorities are trend/growth people. By their actions, they seem to be letting it go again, if you look at how much credit growth and fixed asset investment they are allowing.”
Foster often focuses on trends within the region that might benefit individual companies (or indeed work against them). For example, there is the construction sector in China, long a focal point for foreign investors interested in the country’s booming infrastructure. Local governments in China have embarked on a new house building program to start building 10 million new homes for their citizens this year. In 2011, it is projected that 70% of new house building started in China will be by the government.
“There’s still lots of posh housing being built too,” says Foster. “We’re seeing strong demand coupled with cheap growth in China right now.”
Taking advantage of bad news, too
The Matrix Asia fund’s short book uses CFDs to realise Foster’s short views. “We can off-set the counterparty risk for these via pledge accounts,” he says. “The downside is that CFDs cost about 20 basis points per trade more than cash sales or purchases, but we see the same liquidity. There’s little real difference between a swap and a stock short. The swap occurs in the settlement. The bank unwinds the swap after the event.”
The fund avoids using index futures, as Foster feels this is not his style. “With an index swap, there is no value added relative to an index, it is a passive position.” This concurs with the investment methodology adopted by the UCITS Hedge database, which classifies UCITS funds wedded to a passive shorting policy as absolute return rather than hedge funds.
Shorting used to be hard to achieve in Asia, outside the more developed markets like Japan. Emerging markets long/short funds would often be forced into using index derivatives to encapsulate a short view, but Foster feels times have changed in the region. Some of the Chinese companies listed in the US have deep liquidity, making it easier to short them. E-Commerce China Dangdang, the internet firm which listed in the US in 2010 with a $272 million IPO, is a good example of this.
China is also a hard market to trade in when some companies are not transparent, or where the government has a stake. In the Chinese internet sector, for example, there are a number of ‘pet’ companies backed by the government. It is also important for investors to avoid those firms which are not likely to be managed in a way that profit is maximised – for example where a parent company uses the firm to park bad debt. Many Asia managers therefore pick their investments very carefully when it comes to China.
“We prefer private companies, and some of these are great,” says Foster. “They are aggressive, focused, long-term oriented. You also need to be aware of how much of their success is based on their connections in the government. An unspoken area is the degree to which many successful Chinese businessmen are the children of senior politicians.”
Corporate governance grows
Transparency in Asian companies used to be a big issue for emerging markets fund managers in the aftermath of the 1997-98 debacle. But a lot has changed in Asian corporate governance since then.
“Transparency is improving all the time,” says Foster. Korea is in the process of implementing an accounting reform plan modelled on the US Sarbanes-Oxley Act and hopes to adopt some generally accepted accounting principles this year. Japan reformed its own corporate reporting systems in 1994-95. That said, being an Asia fund manager means still being very active in terms of research, and maintaining rigorous stop-loss policies. Japan leads the region in disclosure terms, and in China, Foster has found that speaking to a firm’s CEO or founder yields little real value: the key is talking to the sharp generation of Western-educated CFOs working within the middle tier of Chinese businesses.
Asia does not currently possess the leverage problems that have plagued some Western companies recently. Lack of transparency may still conceal problems in some Asia-based companies, but it is less of a systemic problem than it once was. Foster feels the potential risks that do exist are analysable. Political risk is less of a problem than it once was, and the situation is improving all the time. Yes, some Asian markets still restrict what firms foreigners can trade freely in, and what firms are protected by maximum levels of foreign investment, but here too, the situation is changing, and listings on exchanges outside the region can also help fund managers to realise their investment ideas.
The lack of Asia-based strategies in the UCITS universe has played a role in the correlating effect we have seen in some strategies (e.g. long/short equity). The universe has had a strong bias towards European strategies in the equities segment. The contribution of performance numbers by the new wave of Asian funds launching this year will be a welcome diversifier, and will certainly help the UCITS fund universe to mature from a geographical perspective. It is a trend that will be welcomed by many fund of funds managers with specialist UCITS vehicles.
