When Rory Dickson was planning a fund to invest in Asian consumer-related stocks, uncertainty over how much money he would start with meant he faced the prospect expenses would exceed the fees he stood to generate.
Instead of setting up alone, in mid-2010 he teamed with Coupland Cardiff Asset Management, the London-based hedge fund group, to start his CC Asian Evolution Fund. They shared his research driven, stock-picking investment philosophy and could provide back-office and marketing support, he said.
“I’ve seen a lot of people invest in infrastructure and just struggle to ever recoup that, limping along for ages,” Dickson, 41, said in an interview in Singapore. “I won’t have to spend days with regulators, risk officers and compliance people; I just focus on running my fund.”
Asia’s smaller hedge funds are sacrificing autonomy for organization to help share costs and meet stricter risk standards demanded by investors in the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy and Bernard Madoff’s ponzi scheme. At least 10 firms in Asia are now offering services such as trade execution and office support, taking a cut of the manager’s revenue or equity in the fund.
Firms that provide hedge funds with operational functions are not new to the U.S. and Europe, where companies such as FrontPoint Partners LLC of Greenwich, Connecticut, and Stockholm-based Brummer & Partners have built multi-manager businesses that offer support to smaller funds. Asian funds, which typically had tried to remain independent, are now more tempted to pool efforts after superior returns failed to attract assets, said Peter Douglas, principal of Singapore-based GFIA Pte.
“Managers’ patience and working capital are running out,” said Douglas, who advises investors seeking to allocate money to hedge funds and runs a wealth-management firm. “The economics will prevail and these deals will start to happen.”
Small managers have been losing out as pensions and endowments shifted to established firms with steady returns and staff dedicated to risk assessment after the global financial crisis saw many funds freeze assets. Firms managing more than $5 billion received about two-thirds of the almost $30 billion in new capital worldwide in the second quarter, according to Chicago-based Hedge Fund Research Inc.
Philip Tye, the Hong Kong-based co-founder and managing director of DragonBack Capital Ltd., said smaller hedge funds can overcome a cash drought by sharing costs to create an organization with the risk and operating standards of a larger firm.
“There used to be something called the Asian pass: investors would come to Asia and recognize that Asian funds were generally smaller and they’d give them a bit of a break,” Tye said. “Now, there’s no such thing as an Asian pass. You are held to the same standards.”
DragonBack, which managed almost $600 million at its peak in 2008, turned into a one-stop shop for managers after closing its hedge funds a year ago. It has already brought onboard Tempus Asian Strategies Fund, an existing $10 million Asia equity long/short fund, and has lined up the Sharp Peak Vega Fund, which seeks to profit from price swings in Asian stock markets, with between $50 million to $75 million by September.
DragonBack expects two more deals by October, including a “significant-sized transition of a well-known manager,” said Robert Lance, DragonBack’s chief executive officer.
“They will more likely go cash flow positive at a much earlier stage, if not even on day one, because we’ve committed most of that expenditure that they would otherwise normally have to do,” Tye said. It currently costs as much as $1 million to “properly” set up a hedge fund, excluding the ongoing cost of running the business, he said.
Singapore-based JL Capital decided to offer support services to other hedge funds to help share its own operational costs after assets under management fell to about $140 million from a peak of more than $1 billion.
“It’s a lot more expensive to set up a hedge fund in Singapore now,” said James Loh, 60, who started the firm’s Swordfish Fund Ltd. in 2003. “Managers can grow their funds side by side with a respectable platform.”
Mark Voumard, managing director of Gordian Capital Singapore Pte, said higher operational costs present a “significant hurdle for managers looking to launch.”
“Institutional investors nowadays typically are focused much more on risk mitigation,” he said. “Therefore a significant amount of their due diligence and investment process is focused on the ability of managers to demonstrate that they can offer operations, legal, compliance and other facilities typical of a larger manager from day one.”
Gordian manages more than $300 million across strategies including long-short equities and global macro funds.
With organizational and risk management demands rising, some managers in Asia are closing. Risk management and transparency are among the top six factors when assessing a hedge fund manager, according to a Deutsche Bank AG annual investor survey. About 100 Asian hedge funds closed down in the 12 months through January, according to Singapore-based Eurekahedge Pte.
“Investor due diligence is now a much lengthier process resulting in a substantially longer gestation period before managers can expect allocations,” Gordian’s Voumard said.
New regulations in the U.S. and Europe are driving infrastructure enhancements in areas such as compliance, risk management and investor reporting, PricewaterhouseCoopers LLP said in a report in June. Singapore is also introducing new rules to increase oversight of the industry.
For support shops, choosing managers isn’t without risk.
“If one strategy goes wrong, it brings everyone else down,” GFIA’s Douglas said. “That sort of cross liability is a risk.”
FrontPoint Partners’ assets fell to $1.5 billion as clients pulled money after one of the hedge fund’s portfolio managers was charged with fraud, a person familiar with the matter said this month. The firm oversaw $7 billion at the start of November, before Chip Skowron, a co-portfolio manager of its health-care portfolio, was alleged by prosecutors to have traded on insider information.
Catalin Burlacu, a former portfolio manager with Millennium Management LLC’s Asian business in Singapore and Barclays Global Investors in Tokyo, is considering teaming up with a firm that can provide his startup, Nexus Alpha Capital Management Pte, with back-office and other operational support. The firm, which runs systematic trading, relying largely on computer models to determine when to buy and sell assets, will need to upgrade its technology as it increases assets, said Singapore-based Burlacu.
“If an investor knows I’m running on a platform which has already gone through a certain due diligence, it’s much easier to get further allocations,” Burlacu said.