Northwest’s assets under management have risen to almost $680 million, said Mark Smith, its Hong Kong-based head of business development, in an interview on April 30. The firm, acquired by RAB in 2006, oversaw about $300 million when principals George Philips and David Rogers bought it back from London-based RAB in April 2009.
Northwest has drawn fresh capital as long-term institutional investors such as pensions and foundations move to concentrate their hedge fund holdings in fewer managers. The global credit crisis plunged the hedge fund industry into its worst annual performance on record in 2008. Almost 2,500 hedge funds shut down globally in 2008 and 2009, according to Chicago- based Hedge Fund Research Inc., and more curbed redemptions.
“Assets are flowing more towards the larger hedge funds in Asia generally,” Smith said in an interview on April 30. Investors now value managers that can generate profit regardless of market directions, instead of those that charge hedge fund fees for riding on stock market rallies, he added.
A Deutsche Bank AG survey released in March found investors have been cutting the number of hedge fund managers they put money in since 2008 to reduce risk and allow closer monitoring.
Direct investments by pension plans and foundations now account for about 70 percent of Northwest’s assets, Smith said. Funds of funds’ share has fallen to 20 percent.
The mix was 70 percent funds of funds and 15 percent pension funds and foundations in 2007, he added. None of its pension fund clients withdrew money in 2008 and 2009, he added.
Northwest invested in global securities when it was set up in 1998 by Philips and Rogers, who met trading Japanese convertible bonds for Cresvale International.
Intensifying competition in the European convertible bond arbitrage market reduced the hedge fund strategy’s profitability. That led Northwest to shift its focus in 2002 to Asia where inefficient markets and investor restrictions paved the way for fatter profits, Smith said.
Smith likened China’s capital market to that of Japan in the 1980s. In the latter case, the majority of companies lacked access to the corporate bond market and turned instead to hybrid securities to fill the gap, making the country one of the largest markets for convertible bonds and cheap options.
In addition to their abundant supply, convertible bonds are sold cheaply in Asia because it’s difficult to hedge the risks by shorting the shares they can be converted into, he said.
The Northwest China Opportunities Fund, a $330 million market-neutral fund set up in October 2003 to trade Chinese shares, convertible bonds, warrants and options, gained 16.5 percent in 2009. It returned 5.1 percent in 2008, the year when the HFRI Fund Weighted Composite Index declined 19 percent.
The $328 million Northwest Fund, an Asian market-neutral fund established in December 2001 trading the same securities in the region, returned 22.5 percent in 2009. It lost 20.5 percent in 2008 when it was forced to sell Japanese securities to meet investor redemption requests.
The company also manages $20 million Northwest Warrant Fund which takes a view on market directions.
Northwest avoided sharper industry losses by limited use of credit default swaps in 2008, said Smith. As banks cut margins, convertible bond funds using such swaps to hedge credit risk had to sell their bond holdings and unwind the swaps to cut leverage, creating discrepancies between the value of the swaps and the convertible bonds, he said.
Northwest typically hedges the credit risk of its convertible bond holdings with asset swaps, in which the owner of a convertible bond sells it to a broker and receives an option to buy it back.
In the first half of 2009, Northwest profited by trading Chinese bonds with government guarantees. About 80 percent of the China fund was invested in convertible bonds at the beginning of 2009. The percentage fell to 10 percent by July, according to Smith.
In the second half of 2009, with Chinese convertible bonds becoming more expensive, Northwest shifted its focus to companies with shares traded on both China’s yuan-denominated and Hong Kong’s stock markets. It bet that the valuation gap between the two, which had widened because of a rally in Chinese stocks, would narrow, said an investor newsletter in January.
RAB acquired Northwest in September 2006 in a push to expand into Asian and market-neutral funds. Market-neutral funds seek to profit without having to take a view on broad market directions. It sold Northwest after its flagship RAB Special Situations fund lost 73 percent in 2008, hurt by bets on Northern Rock, the first U.K. casualty of the credit crunch, as well as investments on natural resources companies.
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