Hedge funds, already entrenched in the US and Europe as a legitimate form of alternative investment, are coming within reach of Asian retail investors.
Singapore has already approved the controlled marketing of hedge funds and a consultation process led by the Hong Kong Securities and Futures Commission (SFC) ended last month.
Supporters and would-be marketers of hedge fund products are keen to stress that today's popular hedge fund products are far removed from the highly geared monsters of several years ago. Possibly the worst example was in 1998 when the US Federal Reserve was moved to launch a US$3.5 billion bailout of hedge fund Long Term Capital Management (LTCM) to prevent damage to the global financial system.
Hedge funds are also blamed, rightly or wrongly, for attacking the Hong Kong dollar's peg to the US dollar, a play that led to the Hong Kong Government becoming a major shareholder in its stock market.
Hedge funds use a vast variety of strategies to generate returns. One common feature is their ability to show performance unrelated (or "uncorrelated", in the language of market participants) to the movement of the markets they play in. A long/short hedge fund, for example, might bet on two stocks in the same market sector moving apart in price, regardless of whether the overall market moves up or down.
The Hong Kong SFC listed some other common characteristics of hedge funds in its consultation paper. Among them are the ability to go both long and short, the use of hedging tools to control risk and achieve returns, the use of leverage and their freedom from regulatory oversight.
The pressure to open up hedge fund investment to retail investors in Asia has come largely from the bottom up; investors are unhappy with the performance of stock, property and fixed-income markets and are looking for alternatives.
Noble Investments SA managing director Patrick J Aregger (pictured) says the hedge fund arm of the Hong Kong based Noble Group says private investors, including retail investors will drive the growth of the hedge fund market in Asia. "The retail investor will demand products from the market that can make money in all sorts of stock market scenarios," he says.
Big investors can already invest in hedge funds through their private banks or investment advisers, but high minimum investment requirements have kept them off limits for retail investors.
This looks about to change in Hong Kong. A survey by the Hong Kong Investment Funds Association found 60% of members were in favour of authorising hedge funds.
The SFC suggested opening hedge funds to authorisation, but imposing high minimum investment restrictions. This would keep hedge funds out of the hands of small investors. An alternative approach would be to allow open access and marketing, as is the case with traditional mutual funds in Hong Kong.
Edward Chin, regional director, Asia for Allen Perkins Portfolio Management says there has been a surge of interest in hedge funds among Asian investors over the past two to three years. "Investors can see that traditional investment strategies don't perform in all market conditions. They are looking for alternatives."
Chin says more education is required on the subject of hedge funds, both for the investment consultants selling the products and among retail investors. "People think of hedge funds as highly geared investment vehicles. But a lot of them aim at achieving a very low double-digit return along with low single-digit volatility. And capital-guaranteed hedge funds are very popular these days, as are capital-guaranteed traditional mutual funds."
Chin says he is broadly in favour of the fund of funds approach for retail investors entering the hedge fund market. Funds of funds invest in a range of hedge funds and strategies, limiting the risk of any single manager under performing.
Peter Reichenbach, managing director of Gottardo Asset Management (HK) offers hedge fund investment to its clients through its Gottardo Tower Fund-Hedge Fund. This is a fund of funds with its investments spread between about 20 managers. The underlying hedge funds represent the full range of strategies from long/short equity and convertible arbitrage to diversified trading and market timing funds. The fund returned 5.75% in the calendar year to the end of September 2001.
Reichenbach says that adding about 5% of hedge-fund exposure to a bond portfolio improves the yield and increases diversification. For some portfolios, he would recommend up to 10% exposure to hedge funds. "Under normal circumstances, a hedge fund is market-neutral. That means market movement up or down should not have an impact on the fund itself. So in today's environment where you are not quite sure about the outlook of bonds, you might want to opt for an instrument that offers you a market-neutral approach."