Once portrayed as clandestine and risky investments, hedge funds have come a long way in shedding the image and are fast becoming one of the most exciting asset classes in Western markets. The fervour has caught on in Asia, where investors have had to constantly grapple with weak equity markets for the past few years, and hedge funds have provided a very much-welcome lease of new life.

The figures in hedge funds look very healthy and the prospects are boundless. It is estimated that there are now more than 8,000 hedge funds worldwide with AUM (assets under management) of more than US$800 billion. According to a hedge-fund industry group, Hedge Fund Research Inc, the industry pulled in the remarkable figure of US$22.2 billion in the first quarter of 2004 alone.

However, even as the industry attracts more interest and is growing in size, there are still some concerns among major market players in Asia.

In an exclusive interview with China Daily, Christopher Lee, chief executive officer of SHK Fund Management Limited - Alternative Investments Division which sources hedge funds based in the US and Europe for investors in Asia, says that while demand is not an issue, finding the right manager can be an onerous job.

"It's getting tougher to find good managers and also hard to negotiate the capacity you want," says Lee. With more hedge funds mushrooming, this means increased competition. Lee concedes that one of the team's biggest challenges would be to find the right manager to suit its clients' needs in Asia. "Good funds are hard to find, the best funds are often closed."

In most cases, investors in Asia are not fully aware of the well-known and well-respected hedge funds based abroad and, more importantly, the various ways to monitor them. Nevertheless, the division's research team has tried to provide additional value and comfort to their investors by making the "extra" checks on hedge funds and their managers. According to him, the selection process of finding the right manager is quite exhaustive and can take anywhere from six to nine months. A majority of the hedge funds which investors in Asia are interested in are based in the US and Europe, and the team often engages private detectives to do background and security checks on the managers, as part of their due diligence, especially in the final vetting process.

"Suppose one manager claims that he's been to Princeton. Did he or did he not? That's not hard to check, but most people don't bother to check. I think if someone lies about where he or she went to school, you have to think about what else this person is hiding," he says.

Lee sees the role of SHK Fund Management - Alternative Investments as more than one which merely aligns interested investors in Asia to US-based or European hedge funds. It goes the additional step beyond that.

One other part of due diligence that the research team has to conduct is the ongoing monitoring of the hedge fund's position to ensure that the managers of the funds do not overstep their boundaries and allow for "style drift".

"One problem with hedge funds may be that it looks good at first glance, but when something happens, it all ends in tears. Our motto is trust, but verify," says Lee.

By providing that degree of comfort, Lee says that its clients and investors are the better for it. "As a financial firm, all we have is our name and reputation and we don't take that lightly. If something goes wrong, even though we are not the investment adviser, our name will be tarnished," he says.

When the division started its business in 2001, the team was well aware that there were excellent fund managers who were based abroad but were generally unknown to most investors in Asia. Leveraging this knowledge, it made the process of joining the two parties the basis of its business model and this continues to benefit investors today.

"We source what we believe are the best risk-adjusted return managers within a certain strategy, and the managers that we ultimately pick are dictated by what we believe our clients want. We are known within the industry to only deliver managers that we believe to be the best," Lee says. Since hedge funds are not set up like traditional mutual fund companies which usually have a large global presence, most of them do not possess enough resources to make their presence felt in Asia, even if they want to attract investment from this region.

"Can you imagine how tough it is for them (hedge funds) to come to Hong Kong, Singapore or Taiwan to do their marketing without any resources? The language and geography (present difficulties) - maybe some of them have never been here before," Lee says. SHK Fund Management therefore carved a niche market for itself by acting as the "go-between" for money in Asia that wants to access top-quality overseas hedge funds.

Lee reiterates that their business model is also different to the local third-party agents representing overseas hedge funds because SHK Fund Management tends to establish a more meaningful relationship with the chosen hedge funds by appointing them as financial advisers to their offshore funds. He believes that the real work starts only after they have sold the hedge fund to their clients; this is when investors need a lot of information, as often the funds' investment strategies are not that straight-forward.

"To answer investors' queries, we need to be in constant communication with the hedge fund. Since our relationship with them is similar to a 'partnership', we tend to get the information quicker," he says. To date, the company has appointed two US-based companies, Annaly Mortgage Management and Strategic Value Partners, to manage its in-house funds. These funds employ different investment strategies using mortgage-backed securities and distressed debt. The company is expected to soon launch its third fund which will be focused on credit opportunities.

Thus, one can see that hedge funds are essentially investment vehicles that will attempt to generate consistent absolute returns, regardless of how the capital markets perform. "In a strange way, weaker equity markets tend to play a little bit to our strengths because we are focused on investment strategies that are non-equity related," says Lee. "From 2000 to 2002, the equity markets in Asia were bad and were affecting investors. By the end of it, investors were saying 'Get me out of this mess, show me a fund that's consistent. I don't need to make a lot of money, and I'm happy with returns of 8-9 per cent but I need something safe'. And overall, hedge funds have delivered and demand for them will continue to grow."

Even though hedge funds may have been performing consistently well over the past few years, investors can also be forgiven for remembering the US$4 billion meltdown of giant hedge fund Long Term Capital Management in September 1998, which tarnished the reputation of the entire industry.

Lee describes this as a somewhat inaccurate portrayal of the industry by the media. "Some Asia single-country funds are down 20 to 30 per cent this year alone, but that's okay. But when a hedge fund is down 20 per cent, which seldom happens, people say that they're risky," he says.

However, the industry which is loosely-regulated may not be that squeaky-clean after all. Just last month, it was reported that a Hong Kong-based fund, CSA Absolute Return, a portfolio of hedge funds run by Charles Schmitt & Associates and managed by founder Charles Schmitt was shut down by the Securities and Futures Commission of Hong Kong for alleged fraud and conspiracy.

Good news may be on the way as there has already been talk of requiring hedge funds to register with the US Securities and Exchange Commission within the next few months. Lee advocates the need for a more "structured" industry. "My concern is that there are now more start-ups that structurally may not be that good. Or funds that may claim to get certain returns, but the traders don't know what they are doing," he says.

(HK Edition 07/08/2004 page20)