Chinese hedge funds face uphill struggle to expand offshore

Chinese hedge fund managers have been lining up to establish operations in Hong Kong and to a lesser extent Singapore, but they face an uphill struggle if they are to build a sustainable business. Some put the rate of survival of mainland hedge funds past three years at just 20%.

“Judging from our experience, the success rate of Chinese hedge funds going offshore could be very low,” said Wang Qi, chief executive of MegaTrust Investment (HK). 

Some three-quarters (77%) of Hong Kong-based hedge funds survive for at least three years after inception, but Wang thinks as few as one in five Chinese hedge funds setting up in the city make it past three years.

William Ma, chief investment officer for the Hong Kong arm of Shanghai-based wealth manager Noah Holdings, was also downbeat about mainland hedge funds’ chances of success. He estimated that about 200 Chinese long/short equity managers were operating in Hong Kong as of the end of July, with about 100 new launches annually. However, there are also typically 50 to 100 closures each year, he said.

Achieving scale quickly is key. To have a decent chance of success, a start-up fund manager needs to attract $20 million to $50 million in seed capital in year one and to reach $100 million in assets under management (AUM) within three years. “Otherwise it would be difficult to survive,” said Wang.

His rationale is simple: AUM of $20 million to $50 million is needed to cover the minimum fixed cost of operating a hedge fund manager. And if a firm cannot expand to $100 million within three years or so, either its track record is no good or investors are not confident about other aspects of the manager, such as its operations or risk management.

But hitting this target is not at all easy. Chinese managers venturing to Hong Kong typically try to raise money from funds of funds, investment banks, private banks or family offices, all of which are known to be supportive of hedge funds. But these entities can be very difficult to deal with, and their ticket sizes are relatively small, a senior industry executive told AsianInvestor.

He said a family office would generally only give a small, start-up hedge fund a few million US dollars and certainly no more than $10 million. Moreover, private wealth clients are known to be more prone to short-term churning of products than institutional investors.

Hence a hedge fund needs institutional money if it is to exceed $100 million in assets. However, institutional investors often won’t look at funds with AUM below that threshold because they don’t want to own more than 10% of a hedge fund, and that means allocating $10 million or less. “For a large institutional investorr," said Wang, "it would be like: 'why bother?'" 

Moreover, institutions usually spend three years observing a new hedge fund manager before deciding whether to invest, said Josephine Chung, director of Hong Kong-based consultancy CompliancePlus.

Sentiment on the asset class doesn’t look conducive either. Asia-domiciled hedge funds suffered net withdrawals of $840 million last month and $7.02 billion in the year to July, reducing their AUM to $55.33 billion, according to eVestment.

All in all, the difficult environment makes it all the more important for Chinese hedge funds to demonstrate their worth – and fast.

In the second in this two-part series, AsianInvestor will assess how hedge funds have succeeded in gaining the trust of institutional investors.