Persistent Edge's Asian niche

Persistent Edge was founded in 2002 and has three principals: Raj Mehta, Xin Huang and Eric Xu. The group is based in San Francisco and has a research office in Beijing. The firm manages $180 million in global and Asian fund of hedge fund portfolios. The Asian fund of hedge funds, launched in April 2003, has returned 14% during 2004 and 8.6% in the first eight months of 2005.

What distinguishes Persistent Edge from its competitors?

Mehta: We consider ourselves a niche fund of funds. We see the fund of funds industry moving towards a bifurcation between traditional institutional fund of funds and what we describe as niche fund of funds. The traditional fund of funds industry is over three decades old, and emphasizes diversification to reduce volatility. These funds tend to be have large AUMs and global distribution.

Niche fund of funds are a newer trend and seek to overcome some of the trappings of the traditional model as they focus on a specialized strategy, region or style niche. Although structured like a fund of funds, we behave more like a single manager hedge fund. Unlike traditional fund of funds, we don't manage for low volatility; rather we manage for absolute return with minimal drawdown. That means for us, diversification is not just about diversifying performance correlations, but more importantly about diversifying downside deviation. We believe our job is to push volatility to the upside as much as possible.

We believe that alpha at the fund of fund level is yet to be fully explored in the industry. We take a somewhat top-down approach to our manager allocations and believe that we can convert beta at the hedge fund manager level into alpha at the fund of funds level. We estimate one quarter of our performance comes from top down asset allocation by thoroughly understanding the risk/reward of each region, strategy, and style and letting that guide our portfolio construction as opposed to passively allocating equally across regions and strategies.

The skill sets of our team members enable us to take this macro driven approach to our portfolio. We all have backgrounds on the buy-side of the industry and have direct, hands on research, portfolio management and risk management skills. Eric Xu has experience as a successful entrepreneur and has worked with one of Hong Kong's largest family offices. Xin Huang and I have both spent time in the public and private equity industries making investments and managing funds.

We believe most Asian fund of funds fit the traditional model, but that there is a significant demand and opportunity for niche fund of funds globally. The growth of investible hedge fund indices is proving a wake-up call for the industry and placing the onus on managers to add value at the fund of funds level, helping to move the industry away from the traditional model and towards the niche fund of funds approach globally.

How do you manage a fund of funds from a macro perspective? Does this involve frequently trading managers?

We don't trade in and out of managers. Protecting and building manager relationships is key to our philosophy. Rather, we manage our portfolio by planning our allocations in advance, and use new capital coming in to rebalance our portfolio on an annual basis. Of course, we do make some tactical top-down decisions in portfolio management that have to be reconciled with bottom-up views on individual managers.

We are very upfront with our managers about our approach and expectations. Our managers generally appreciate our approach, and we have even had cases where hedge fund managers have personally invested in our funds.

What was the rationale behind deciding to focus on Asia?

Although we have a global fund of funds portfolio this is mostly invested in blue chip funds that we have access to through our networks. Asia is the strategic focus for our firm. The region is well suited to the macro driven niche fund of fund approach we favor. There are significant structural changes and corporate reforms taking place and there are a lot of market inefficiencies in the region.

There are few areas in the world where informational asymmetries can still create opportunities. These circumstances make Asia a great place to extract alpha both at the single manager and at the fund of funds level. We believe our Asian fund of funds can achieve better risk-adjusted returns than a top performing single hedge fund manager.

How does investing in Asia hedge fund managers compare to managers trading US strategies?

The US markets are certainly more mature and there is more talent developed on the buy-side, but there are also less market inefficiencies. Having begun its modern incarnation in the 1970s, the US hedge fund industry is already in its fourth generation where as the Asian HF industry is still in its first/second generation.

In general, the quality of US HF managers is superior (especially in areas of portfolio management and risk control), but opportunities are fewer and further between. On the other hand, Asia has much more opportunities for hedge funds but far fewer managers, especially highly-skilled ones.

We are witnessing some strong alpha generation in Japan, but very polarized and isolated to a small group of managers with a strong information advantage. In Asia ex-Japan, historically we have found even the best hedge fund managers as not being able to overcome top-down factors like geopolitical issues, market liquidity, fund flows, and investor sentiment. We do see this changing in real-time this year especially in areas like India, Hong Kong, and Korea. Over time however, we expect Asia to deliver many more alpha generators as the markets mature and the industry grows further.

Who are your investors?

We started with U.S. family offices and individuals, including several Wall Street professionals, then Europe and more recently Asia. Our current investor base is primarily family offices and some smaller institutions.