assets under management totalled around $350m at the end of May 2008.
Subject to regulatory approval KGR will shortly become part of LGT Capital Partners, a Swiss-based alternative assets firm which manages over $17 bn of assets.
The company currently manages three open-ended Cayman funds – the KGR Capital Asia Pacific Absolute Return Fund, the KGR Capital Asian Dynamic Absolute Return Fund, and the KGR Capital China Absolute Return Fund – plus the Guernsey-domiciled London-listed closed end KGR Capital Absolute Return PCC Fund.
The multi-strategy KGR Capital Asia Pacific Absolute Return Fund was launched In August 2003 and has produced annualised return of 8.40% with volatility of 5.18%.
The more aggressive multi-strategy KGR Capital Asian Dynamic Absolute Return Fund was launched in September 2005 and has produced annualised return of 10.43% with volatility of 8.60%.
The London-listed closed end multi-strategy Asian fund, the KGR Capital Absolute Return PCC Fund,
was launched in November 2005 and has produced annualised return of 7.11% with volatility of 7.53%.
The company recently announced a ‘C’ share issue for the fund. KGR plans to raise up to £60m and has issued an additional 4.3m shares in response to investor demand.
The KGR Capital China Absolute Return Fund was launched in June 2007. It has a concentrated portfolio of managers trading strategies and markets in the Greater China region. The fund has produced return of 4.45% since launch.
The company is also planning to launch an uncorrelated non-directional market neutral version of the KGR Capital Asia Pacific Absolute Return Fund. Called the KGR Capital Asia Market Neutral Fund, it will aim tor generate an annualised return of 8-12% with volatility of less than 4%.
Q: We spoke to KGR Capital’s chief executive Mark White and started by asking him to explain the background to the company.
A: KGR are three ex-colleagues of mine at Jardine Fleming – Knox, George and Rampton. Chris Rampton and I were colleagues on the management committee at Jardine Fleming Holdings in the latter half of the ‘90s. Chris ran the investment bank and I ran the investment management business.
Jardine Fleming was arguably the most successful investment bank in Asia in the ‘90s. The company was taken over by JP Morgan. Knox, George and Rampton were all on the security side. They left relatively soon after the takeover and set up KGR Capital, because they saw that Asian hedge funds were not really a big thing in the ‘90s for various reasons. Mostly because Asian governments discouraged hedge fund behaviour and as a result there weren’t many in existence.
After the Asian financial crisis in the late '90s policy gradually changed amongst Asian governments. They realised that previously they had been pursuing a ‘copy Japan’ strategy. While some parts of Japan were successful it was dawning on everybody after the Asian financial crisis that copying Japan for ever wasn’t a very good strategy, because Japan wasn’t doing very well any more.
One aspect of the Japanese model was that capital tended to be allocated by governmental dictat rather than by capital market efficiency. Once that sort of thinking gradually got debunked because the Asian financial crisis was so bad it was obvious that inappropriate borrowing had occurred and the wheels fell of the cart. Without announcing a change of policy the reality was that most finance ministries in Asia figured out they needed more efficient capital markets, and the only way they were going to get those was to stop shooting hedge fund managers or anyone else that did anything innovative.
Liberalisation of Asian capital markets created a huge opportunity for Asian hedge funds to come into existence, whereas previously you had very few. That in turn gave a niche for people who very knowledgeable about the Asian region and also knew most of the people that were likely to be starting and running hedge funds because they either brokered with them or employed them. The universe of hedge fund managers was quite small and collectively they must have known all of them when they started out.
The firm was started in 2002. I joined in 2005 because at that point the business had grown a bit. Obviously the knowledge of the hedge funds themselves and the managers is very important but also somebody with an asset management background was also quite useful, because there are some aspects of running fund of funds which are just like running any other fund management business. I brought the fund management expertise. I was running the JP Morgan Asset Management’s institutional business at that point.
The vision that I had was that I would be able to institutionalise the business of KGR in terms of its client base. By institutionalised I mean get European pension fund clients to give KGR money, perhaps through subscribing to an offshore fund or as a separate account mandate.
It hasn’t quite worked out like that. The reason is because what I discovered is that there is a lot of demand for an investment trust version of an Asian fund of hedge funds. I came up through the Fleming organisation and Flemings have always had a big involvement with the investment trust business in the UK. There is not a comparable business in most other countries. You either know about this business or you don’t – and I was fortunate enough in knowing about it.
So we created the KGR Absolute Return Fund. It is not actually an investment trust. It is a Guernsey-domiciled investment company listed in London. That appeals to a number of different types of UK tax payers – life insurance companies, private individuals, family offices and to some extent self-managed local authority pension funds as well. So I spent more time on this fund than on the institutional side. And we are now in the middle of a ‘C’ share issue which is raising additional capital for the fund.
Q: What was the motivation behind setting up the fund of funds structure?
A: In a perfect world all you would need to find would be the perfect Asian hedge fund and then you would not need a fund of funds. But we do not live in a perfect world, and I’m not sure there is a perfect hedge fund. In terms of risk and diversity it is better to have a basket of different hedge funds, rather than putting all the eggs in one basket by trying to pick the perfect one.
Hedge funds are relatively undeveloped. The hedge fund industry in Asia is new. The age, experience, organisational robustness of the firms involved is all much newer than in the US or Europe. There is an element of risk at the fund level because it might blow up for a number of reasons.
We felt there would be a lot of people interested in someone managing a basket of these funds, using their experience to pick the best funds but also to put them into a portfolio which would have diversification characteristics that would give them an attractive risk return trade off. What we are not trying to do is produce returns similar to a direct investment in Asia produces. It is high return but it is very high risk. They tend to be more volatile markets.
What we are trying to do is enable people to invest in Asia and the Asian hedge fund opportunity but with lower volatility. That is done better by having a diverse basket of funds that do not all go up and down at the same time. It was a great idea and broadly speaking we have delivered that. We have produced good steady returns with a lot less volatility than by investing directly in Asia, or from buying a single Asian hedge fund.
KGR Capital’s chief executive Mark White
Q: What was the thinking behind setting up the different funds, starting with the KGR Asia Pacific Absolute Return Fund?
A: It was established in 2003. At that time people were pretty risk adverse about investing in Asia because of SARS which meant that there were a lot of basic health worries. As befits those times the objectives of this fund were very conservative – 10% absolute return, less than 6% volatility – i.e. low volatility and steady return, which is absolutely what it has achieved.
Gradually what we have been doing is populating the risk return space below 10% volatility. More than 10 - 15% volatility is more like long only returns, but we think that the value of hedge funds is that we can produce in this case 10 – 12% returns with 4 – 6% volatility.
The KGR Absolute Return PCC Fund, which was established in November 2005, is slightly more volatile but with slightly higher returns – 12% plus return with 6-8% volatility.
Around the same time we also launched the slightly more dynamic version of that fund - the multi-strategy KGR Asian Dynamic Absolute Return Fund, which aims for 15% per annum return with volatility below 10%.
Last summer we launched the KGR Capital China Absolute Return fund which is much more risky than the other funds and is focused solely on Chinese hedge funds. We recognise that this is a very early stage in the development of hedge funds in greater China, but we did feel that there was some opportunity for us to put a toe in the water for clients that were interested in doing so too. So we have ended up with a complete sweep of funds filling the space in the risk/return spectrum.
We are also planning to launch either at the end of June or in July a new KGR Capital Asia Market Neutral Fund that will have a very low level of risk and very low beta. It will try to capture returns in the non-beta space because a lot of people say Asian investing is ultimately about riding the big waves in the market, and that you cannot capture alpha without a lot of beta. The fund aims to be uncorrelated to Asian markets and will look for pure alpha in the Asian hedge fund space.
Q: Have you attracted different types of investors to the different funds?
A: They are aimed at both different types of investor and also the same investor in different moods with regard to Asian investing. All of the senior people within the firm have more than thirty years experience investing in Asia. The Asian economic story is clearly very good.
When we started in the investment business thirty years ago people needed persuading of that but these days they don’t need persuading because it is self-evident to everybody that Asia is a very successful economic region. But converting that into successful investment returns has been quite problematic because of the volatility of Asian markets. They are still very volatile relative to other markets and the volatility tends to produce over-enthusiasm for investing after the Asian markets have gone up a lot, and then insufficient enthusiasm when they have gone down a lot.
The principal of investing in Asia should be right given how economically successful it has been and looks like continuing to be. But westerners have not always been as successful as they should have been, because they have basically overstated their own tolerance for risk.
The attitude can be ‘this is all going brilliantly for ever’ and then something goes wrong, such as SARS or the Asian financial crisis or the Internet bust, and then it changes to ‘oh my god, I’ve invested in the other side of the world, which I don’t understand’, and they pull their money out just at the wrong time.
So we are really keen on producing smooth returns, which we hope will get over that problem and give people the confidence to stay invested longer term and capture the opportunities that undoubtedly exist.
Q: Are they predominantly European investors?
A: Yes although we do have some Asian investors, not a huge number relative to the west. Why is that? I think there are a number of reasons. The other side of the Asian hedge fund industry itself being new is that Asian investors have not traditionally been big investors in hedge funds. The traditional big investors are in the west. It may be slightly a chicken and egg scenario. As Asian hedge funds get bigger and more successful then Asian investors will be more likely to invest in them.
Another possible reason is that Asian investors tend to have a more hands-on approach to investing. Some of the big Chinese families, for example, act as hedge funds in their own right effectively by having a diversified portfolio of assets and families operating in different types of industries in different countries.
The reality is that the biggest investors in hedge funds worldwide are US endowments and European pension funds, and European private banks. That is true of global hedge funds and there is no reason why it should be any different for Asian hedge fund of funds.
Q: And that’s true for you too?
A: Half of that is true. We haven’t done a great deal in the US. Our client base is principally UK and European with a relatively modest amount of Asian and American clients. That is more to do with resourcing and prioritisation and spending more time doing UK-related business because of the success of the UK-listed vehicle in the UK. Arguably that has been at the expense of perhaps spending more time in the US.
We are in the process of being acquired by LGT Capital Partners, which is a Swiss-based alternatives investment firm. We think that one of the benefits will be to enable us to get access to a broader range of institutional investors, particularly in the US and continental Europe. This will provide us with a greater distribution platform to access institutional clients.
The deal is subject to regulatory approval. As far as we are concerned the deal is agreed. It is only pending approval by the SFC in Hong Kong and the FSA in the UK.
Q: Presumably there would be all sorts of implications for KGR as a company should the deal go through as planned?
A: Surprisingly not that many because it is a very good fit. LGT does not have an office in London. It is quite unusual for a $17 bn alternative asset management company to not have an office in London. We will now be their office in London. We only do Asian fund of hedge funds and that is an area they want to build up their capability in. And they do not have any Asian specialist products in their product range. So again that is a perfect fit for them. On a practical level we will continue to do what we do on a day to day basis as usual, running the same funds.
LGT have two businesses - global fund of hedge funds and private equity. Private equity is slightly bigger than hedge funds obviously but we will have more involvement with the fund of hedge funds side.
Q: Did the reputation built up by the success of the original fund, the KGR Capital Asia Pacific Absolute Return Fund help to attract new investors?
A: Definitely. At the end of last year after four years of existence it was exactly on target. It has slipped a bit behind target in the first few months of this year, but we are confident that we will be back on track by the end of this year again. It proves that we have a consistency over the cycle and credibility with the client base.
Q: What is your investment strategy?
A: The way we work is that there is a rapidly growing universe of hedge funds in Asia. There were about 200 funds specialising in Asia when we started in 2002, and there are about 1200 today. So there has been a rapid increase of hedge funds. At a fund level we want to be sure that we are aware of which funds are the best, in terms of consistency of return and doing what they set out to do.
From a top-down point of view we also use our experience of Asia to select which types of hedge fund are more likely to succeed in different environments – for example, ones that are dedicated to Japan, ones that are dedicated to China, ones that do convertible arbitrage or ones that do equity long/short.
On a day-to-day basis we are relying on the fund managers themselves to be successful in what they do, and produce the returns that we need. But over a nine to twelve month view we shape the portfolio by allocating to different types of strategy over nine to twelve months.
In 2007, for example, we had very little invested in Japanese equity long/short and we had quite a significant exposure to volatility arbitrage. Both those strategic initiatives were successful because Japanese hedge funds had a terrible year in 2007, and although volatility was very low in the first half of last year it spiked dramatically in the second.
We therefore had good returns in 2007 partly because our underlying managers did well and partly because we allocated to strategies which were the right ones to be in. It is a mixture of identifying successful fund managers or hedge funds and allocating to the type of fund appropriate to the circumstances.
Q: Are there any strategies you are avoiding?
A: Right now we are very low in Japan equity long/short but whether or not that is still a good negative bet is more open to question now that it has been for eighteen months. It is quite a topical issue. The problem with Japanese equity long/short funds has been that they have been very long small cap companies and tending only to short large cap companies. During this period small cap companies have got cheaper and cheaper because the market has been giving up on anyone being able to unlock any value from them because of the anti-reformist tenor of government policies. Meanwhile relatively large cap have done better so there has been a very bad outcome for many of those firms pursuing those strategies.
I think there are signs that there is some change occurring in Japan. We have just started nudging up our Japanese exposure a little bit in the last month or two but very cautiously. Japan has been a bit of an oddity since 1989 and sooner or later it has got to rejoin the planet. Is it going to do so right now? I think we are quite cautious about that. But it is unlikely to remain as out of step with the rest of the world as it has been in the last few years when it has been quite remarkably out of step.
Q: Do you target any particular sectors?
A: We are continuing to increase our exposure in non-directional – that is a general bucket to anything that does not have a high beta to the market. Broadly speaking that is equity long/short, which could be market neutral. That is by far the biggest single strategy in the Asian universe – long-biased equity long short is probably 55-60% of the universe. So having that or not having that is the first big decision.
We have moved from a position last year where we had quite a lot of that allocation, to a position where we are trying not to add any long-biased funds to our portfolios. We see ourselves in a period of very choppy markets, and a long-biased fund is going to tend to be wrong more often than they are right until position become more benign. So that is a broader bucket.
Now within that non-beta area we have a relatively large exposure to volatility arbitrage. We think markets are still quite jittery and volatility will remain somewhat high, but I think we are probably past the point of greatest interest in volatility arbitrage. Some other areas are becoming interesting again, such as distressed debt with the credit crunch leaving some wreckage, and fixed income where there are generally some opportunities. But fixed income is still very small in Asia. Asian bond markets are not very well developed so the Asian fixed income hedge fund business is still quite sparse. Even when we are focussing on non-beta strategies there will still be quite a considerable equity component because fixed income is such a small part of the Asian universe.
Q: What have been the key drivers of asset growth?
A: I think people’s interest in Asia is the underlying reason and the Asian hedge fund industry in particular. When we started selling years ago you had to spend the first half of any meeting persuading people that Asia was going to be a very successful economic region. In recent years you haven’t had to spend any time with any client persuading them. You spend 100% of your time talking about how they convert that economic success into investment success.
People are very interested in the potential of a relatively new component of the hedge fund industry, which is the Asian component that has previously been lacking. There is novelty. There is inefficiency in markets. People are quite ready to believe that Asian capital markets are less efficient than for example the US ones because they are not as developed, they are not as integrated or tightly regulated. They have only really got the idea of efficient markets – this is a generalisation – in the last ten years, whereas the Americans have been pushing this concept ever since the Second World War.
There is a general interest in Asia and Asian hedge funds. There are not many people doing it – perhaps a dozen firms like ours worldwide – so it is a very specialist field. It depends on the attitude of the investor towards alternatives.
There is a huge spectrum of attitudes. On the one hand, there are still people who think that alternatives are a flash-in-the-pan and that everyone will go back to traditional equities, bonds and cash when they come to their senses. And that it is all a myth put about by expensive investment bankers that raise their fees.
Others think that it is not a flash-in-the-pan and that over time markets and products will become more sophisticated. We are very much at the ‘this is only the beginning’ end of the spectrum. While Yale and Harvard, for example, have got 40% plus in alternatives most institutional investors worldwide have probably not even got 10%. We think it is a very early stage and that combined with the relative immaturity of Asia we think there is a lot of potential for increasing their allocation to alternatives. And then having an allocation to Asian hedge funds is a sub-component to that
Q: Does KGR have an investment philosophy common to all the funds?
A: Basically it is a belief in Asia. Not to the exclusion of everywhere else, it is just that we witnessed the most dramatic economic development the world has ever seen in Asia over the last thirty years. From a billion people most of who were poor there are now five billion people most of whom are likely to rich in a generation. That is really a huge change and underpins our belief that we are doing the right thing in terms of investment.
Obviously that is a positive backdrop, but the challenge has always been in Asia converting that obvious economic success into investment success which is a little bit trickier than it might look.
Q: What do you think sets you apart from other fund of hedge funds?
A: Asian-orientation obviously.
Q: Other Asian-ones?
A: Ultimately our people and the breadth of our experience. This is a sweeping generalisation but the standard model for an Asian hedge fund of funds is one relatively experienced person and lots of gophers. There is nothing wrong with that but that is the traditional model.
As a result of company history we have a strong team of research people on the ground in Asia, but we also have a broad swathe of experience, and different types of experience – geographically, professionally in investment banking, securities and derivatives, investment management as well. We have a much broader panopoly of experience and a lot of vigorous research people on the ground as well. Our breadth of understanding of the region and the components of the Asian hedge fund industry, and the relative backgrounds of people is what distinguish us from the others.
Q: When you speak of Asia do you mean you are targeting some specific countries more than others? You set up the Greater China-oriented fund, for instance.
A: We do. To put it into perspective there are now more hedge funds focussing on Greater China than there are focussing on Japan. If anyone had made that statement five years ago we would have said they were mad. Japan is the second largest economy in the world, and the largest economy in the Asia region. It has the most developed capital markets. There is no reason on earth why it should not have a bigger and more successful hedge fund business at its stage in development than Greater China, which is very early in terms of creation of markets, liberalisation, capital flows etc.
That is a most counter-intuitive development. The reasons for it are half how badly Japan has done in the past five years and half how quickly Greater China has evolved in terms of capital market development over the last five years. That is the most single striking event and you have got to be cognisant of events of that magnitude occurring in your patch if you are a specialist.
I am not belittling the rise of Indian capital markets – that has been very significant as well – but I would say it has not been as thorough going, as dramatic or as complete as the China development.
But when we were debating China there was a discussion as to whether we should consider a China or India fund and it was quite a close call. But in the end we found a broader diversity in styles and better operational developments in the China space than currently exists in the India space.
Q: And you have an office in Hong Kong?
A: The location of the office should not overly predispose us to China-oriented products. Our head of fund research is Indian and spends a good deal of time in Delhi. Myself, Chris and Ed have all done work in Japan and in a commodity-driven environment Australia is very important to our universe. Yes, our research hub is in Hong Kong. We think that is very important but it does not necessarily predispose us to being China-centric. We definitely are a regional firm rather than just a China-centric one.
Q: You mentioned commodities. When you were talking about sectors you didn’t address any in particular, and covered strategy-style more?
A: There are two challenges with commodities for a company that is Asian centric. One, Asia is not particularly endowed with commodities relative to its demand. Two, commodities generally are globally traded rather than regionally traded. So what do we mean by regional commodities? We do have problems fitting commodities into an Asian geographical specialisation.
We are constantly looking for managers who are active in the commodity space but only in Asia. We have had some in the past but unfortunately the most successful ones that we have had have tended, as they have got bigger, to move their briefs from being purely Asian to going global and we have had to move them out of the portfolio.
But we are continuing to work more in that space and we do see that Australia in particular has a natural affinity with the resource hungry countries to the north of it. We are constantly looking at ways to exploit that either directly or through managers of Australian hedge funds themselves exploiting that opportunity via event-driven strategies because of takeovers and mergers between miners and other miners or resource-hungry industrial producers backward integrating their supply chain.
Q: Do you have any specific thoughts about risk management?
A: We do monitor risk management very closely, both at the fund level looking at what the risk characteristics of the fund are and at the portfolio level. It is possible to have two risks and because they are uncorrelated they can balance each other out. That is part of the reason for having a fund of funds rather than a single fund.
There has to be a bit of a health warning in this space though, because a lot of risk management is based on statistics and if there are only a small number of data points because both the funds and industry are very new. Unfortunately statistical analysis gets better the longer the time period and the more data that is available. We are starting from the position of being relatively data short in a data short part of the hedge fund industry. If all the fund managers under scrutiny have got ten year track records, as might be the case in the US, then the result is probably a more statistically significant database on which to base the analysis.
We do have all the analytical tools but we cannot create what does not exist. We have to overlay whatever the statistics are showing with a fair degree of experience – does this smell right, is this likely to be ok etc – which is all part and parcel of having a very experienced team supplement the quantitative analytics just cannot get hold of.
Q: Do you have any market predictions?
A: I guess what I said about our strategies gives our immediate future review, which is that it is going to be choppy. Markets will be bouncing around current levels in a rather volatile way, as they work through the challenges of very high oil prices in particular and commodity prices generally. Food prices too – rice prices in Asia have been a huge negative on consumer sentiment, not to mention the earthquake and the cyclone. There are a lot of headwinds in terms of sentiment.
Asia has not been the most affected by the credit crunch. It is through exposure in its exports to the west but in terms of direct exposure they are not very geared. The banking system is not anything like as affected in Asian markets as it has been in the west. Relatively speaking Asia is in better shape than the west medium term and that would suggest that on a two to three year view we will see Asian markets out performing Western markets. But right now the so-called ‘de-coupling’ that everybody was talking about last summer is a myth. You will never get Wall Street going down and the Hang Seng going up. It just doesn’t happen because it is the same liquidity pool.
Over time if growth is low in the west and it is much better in the east there will be relative outperformance of Asian markets but not in coincidental fashion. It is always in a sequential fashion. If sentiment is bad in the west, it is going to be bad in the east - in the short term – which is why we are not keen to get high beta strategies. We want low beta, high alpha strategies. People who can take specific trading or arbitrage opportunities and make money out of them.
Q: Because your funds are operating in that space, you’re not trying to decouple from other hedge funds?
A: Exactly. We are trying to produce all weather returns – that is the whole point of an absolute return fund. These are very challenging times but we still look to our underlying funds to produce positive absolute returns in difficult conditions.
As things stand we have not achieved that year to date but we are still in the first half of the year. But we hope and believe that during the second half that the managers and our selection managers will manage to achieve that.