More cleansing for AsiaÆs hedge funds

Mikhail Baryshnikov-lookalike Thomas Della Casa is the Swiss-based head of research in Man Investment's analysis and strategy group. He spoke to AsianInvestor during his visit to Asia this week.

How did the Man Investments' stable of funds of funds perform in 2008?

Della Casa: AHL had a great year and was up 33%. RMF's broadly diversified product did better than the rest of the industry. Our commodities products have maintained their capital, which is excellent in this environment. A focused product like dynamic selection with a portfolio of about 30 managers was down 6%, which was quite a good result.

Have you experienced a lot of redemptions?

We have seen some redemptions to the end of Q4, but compared to some of our peers we are in a sweet spot. The good thing is that we have never suffered from any liquidity mismatches, so we are able to return money.

Can you comment on the investments Man placed with Bernard Madoff?

I'm not allowed to say anything on this subject because of legal proceedings and criminal investigations.

Have changes been made to the way Man does due diligence?

Strict changes have been made already. No more indirect investments, because the Madoff case showed that it is possible to hide behind third parties. There will be an enforcement of more face-to- face meetings with managers. There will be a rejection of managers who are administrated and operated by entities for which we have no name recognition and haven't appeared in the hedge fund universe before. 

Do these strictures make life harder for new managers who want to raise money?

Not necessarily, because new managers can be more transparent. We can tell them who we would prefer them to work with -- their administrator for example. Also the money that we typically allocate to new managers would be on the basis of it being a managed account. Our parameters are very strict.

Do you foresee more hedge fund closures in 2009?

Yes, in order to meet redemptions. A lot of institutions have balance sheet issues, for example the US endowments and insurance groups, both of whom need to generate cash in order to meet their commitments. The industry has already consolidated quite a bit, but there should be more consolidation. Globally, there remains a concentration on the funds with bigger-sized assets under management of over $1 billion.

Smaller hedge funds will find it more of a struggle unless they have a niche, or are in 'build up' phase or offer something else special. I think exactly the same applies in the fund of hedge fund business.

Do you foresee any further legislation and regulation being applied to hedge funds?

Regulation will increase. Man isn't against regulation which is sensible and has participated in working groups that research this issue and seeks to improve standards without preventing people from doing business.

The restricted shorting episode of 2008 wasn't a successful one for regulators. Spreads increased and liquidity left the market, and that in itself caused downward pressure. They would have been better off just closing the market completely if they didn't want people to sell -- though that would have been a bit extreme. I don't think we'll see that reaction again.

Once their lock-ups expire could the survival of any of the big international hedge funds be in question?

It depends why they put up gates, and why they put them up.

There's three ways you can react if you have liquidity difficulties. You can create a side pocket, meaning you can still give liquidity to your investors through your regular share class, but you give an additional share that is illiquid. I think side pockets are a reasonable solution as it gives the investor the message that he will get his money back at a better price in the future.

The second thing is the gate, which is also not an unusual occurrence, but it depends on how the hedge fund does it, how big it is, and how it communicates this to its investors. The most appreciated way is to give as much notice to investors as possible.

The least preferred way is to suspend redemptions, which implies there was something wrong in your investment approach. Quality shops have cash put aside to meet redemptions.

Where will you be allocating this year?

We favour trading strategies. Discretionary trading, systematic trading and trend following I think is where money can be made in the next two to three quarters. I don't think it is time for risk capital to come back into the market until the banks and their balance sheets are fixed.

Asia doesn't have a banking crisis or toxic debt and the banks have reserves, but Asia is still a long/short type market. That strategy still accounts for 80% of Asia's hedge fund activity. Our overall tactical asset allocation is not too keen yet on being overweight equity strategies, because we think macro news will remain negative and it is not time to hugely build up that strategy. 

Asia's hedge fund business is at an early stage in the growth cycle compared to the rest of the world, but I think there will be a cleaning out process here, as there were some big disappointments with some hedge funds.

Distressed opportunities are building up. Defaults are going up. You need to buy into distressed shortly before the peak in default rates. We've already started to increase allocations, but the timing is not quite ripe yet for distressed and special situations.