Asia's hedge fund renaissance

Asian economies are well on the road to post-crisis recovery - thanks to a combination of measures that together have served to reduce the region's systemic risks, with the main factors being the marked improvements in bank regulations, exchange rate regimes and foreign reserve levels. Demand for hedge funds in Asia is soaring, as the formerly much-maligned hedge fund industry enters a phase of significant growth. This remarkable turnaround is perhaps an implicit acknowledgment that hedge funds had been unfairly indicted as one of the major contributors to the crisis when it was the complex interplay of other macro factors that were ultimately responsible for the meltdown; factors such as overwhelming levels of foreign debt, high domestic interest rates and too rapid a liberalization of currency markets.

The Golden Age of the Hedge Fund in Asia - Alternative Investments Enter the Mainstream

Even back in 1997, there were murmured predictions that hedge funds would, in the next five years or so, come to be regarded as simply another asset class that investors would buy just like any other. That day seems to have arrived. Indeed, the growing popularity of hedge funds as an investment vehicle in recent years is well documented.

"More and more institutional investors within the region have sat up and taken notice of the benefits of alternative investments in terms of diversification and return potential, and have started to allocate significant amounts to alternative investment strategies," observes Michael Drennan, Standard Chartered's Global Head of Hedge Fund Sales.

"Baby boomers and Generation X sectors of the population are all looking for ways to augment their traditional investments, or in some cases to replace that relative return investment," he notes.

"It is mildy amusing to consider the picture, some time in the future, of a retirement home cheering as the Kospi drops 4% in a day. They all have their cash in a fund of hedge funds, currently short the index."

The Search for Alpha and the Competitive Landscape

The search for alpha has made hedge funds attractive to even the most conservative fiduciary investor. The industry is awash with investment dollars that continue to flow steadily in. At the same time, as Asia's hedge fund industry grows more populous, competition has naturally intensified. There are now approximately 6,000 hedge funds in business with roughly $800 billion in AUM at the end of 2003. And when you factor in leverage, the figure is closer to $2 trillion to $3 trillion.

In Singapore alone, the number of hedge funds managed there has grown from a little over 10 to more than 49 within the space of 18 months. (source: PwC / Eurekahedge Research, August 2004)

"The doors to the hedge fund world have been blown open," declares Drennan.

"Hedge funds no longer make up a boutique segment of the vast array of investments available to the professional or indeed the retail investor. Such growth has increased competition within this sector significantly," he observes. "Hedge funds are here to stay, and this presents ever-changing demands and opportunities for the banking sector servicing their needs."

The need to perform and indeed differentiate has driven funds to look for absolute return in markets outside the mainstream. Funds now watch and trade markets in China, Thailand, Taiwan, Korea, Philippines, Indonesia, India and many others.

"The rise in competition in the hedge fund sector has left hedge funds looking beyond the traditional G7 orientated bank partners," he notes.

Partnering for Performance - Asian expertise

Drennan believes that the hedge funds' focus on Asia's growth markets plays straight to Standard Chartered's unique strengths.

"We have been in Asia for over 150 years, and that means we are, to all intents and purposes, practically a local bank," he says. The bank's strong on-shore presence in these markets, he points out, counts for a lot with clients.

"We see a strong demand from hedge funds seeking capability in accurate, locally-sourced intelligence, execution and a tailored delivery in FX and IRD products. They rely on us to be their eyes and ears on the ground in Asia."

Indeed, Drennan is of the view that the bank's competitive advantage lies in its understanding of the markets in which it operates. "Our edge is that our natural business - where we do business on a daily basis - positions us to provide tangible pricing and information benefits to our clients," he explains. "Our local consumer bank in both Hong Kong and Singapore provides us with option price advantages as a result of our large presence in the popular Dual Currency Deposits market. Such participation provides us with a heavy skew in our FX volatility book. We have been successful in providing cheaper access to volatility for hedge funds in both AUD and NZD. This ôaxe" pricing is normally in the shorter tenors of 1-3 months but is an extremely attractive proposition to a hedge fund looking to transact significant volume in a very price sensitive market."

Leadership in FX and Liquidity Management

Funds also look to Standard Chartered for its strength in the regional currencies. Drennan highlights that the bank's access to the local currency markets is virtually unrivalled. "We are recognised as one of the leading FX banks in Asia, Africa and the Middle East, and actively trade in more than 100 currencies, with exceptional strength in exotics," he says.

He also points to the growth in FX-focused hedge funds and the surge of interest in emerging FX markets.

In July 2003 in India, a noteworthy step was taken to develop the market and provide onshore customers with greater hedging flexibility when the Reserve Bank of India permitted authorized dealers to offer FX-Rupee options.

Such reforms unlock the full potential of the bank's onshore presence, and serves as a platform for it to guide clients through the liquidity and risk management aspects of the country's FX market.

"We are the largest international bank in India in terms of profits, assets and branch network, and we transacted the first on-shore foreign currency - Rupee option when that market was launched last summer," Drennan remarked.

Elaborating on the bank's strengths in other key markets, Drennan adds, " In China, we are the oldest foreign bank, having maintained a continuous presence and having been actively involved in that market since 1858. This type of local presence undoubtedly gives us a source of intelligence for reading events and assistance in predicting trends that is very attractive to our hedge fund clients.

"Does your bank offer option pricing in over 100 currencies and run an option book in Saudi, Tanzania and Botswana? We do."

Drennan sees liquidity management as another major consideration when trading in the markets where the bank is a significant market maker.

"Hedge funds professionals are very experienced, and often come with an investment bank or trading background. They have a reputation of trading in sizeable volume and expecting pricing standards that not all can meet, especially in the less generic markets," he states. "Such is our market reputation: we regularly transact business on behalf of other major banks in these markets in addition to our own client base. The confidence that our competitors have in us is truly an indication of the day to day capability we employ."

The recent moves by EBS to provide hedge funds with access to G10 FX currency pricing, via their platform, serves to demonstrate just how competitive the generic service has become.

As to Standard Chartered's proposition for hedge funds, Drennan has a clear vision of the end-goal. "Standard Chartered aims to lead the way in the provision of emerging markets coverage in both the regular manner and on an e-platform, a step not easily replicated by many of our competitors," he states. "The participation in such a development is far more complex and niche than that of G7 provision. We find ourselves ideally positioned geographically and very motivated to devote unique resources, and time, to assist both current and new hedge fund clients to participate efficiently in new and ever developing markets."

With its unique geographic footprint and keen focus on its strengths, allied with the expansion and diversity of the hedge fund industry in the developing markets, Standard Chartered is indeed a strong partner to the hedge fund industry.

Michael Drennan is Global Head of Hedge Fund Sales, Standard Chartered