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Due Diligence on China Hedge Funds
Thursday, 4 February 2010
Controversy issue has been raised
upon the investability of mainland
China based managers,
AsianInvestor reported
Singapore-based research firm GFIA
has stopped covering and investing
in hedge funds based in mainland
China. It has largely shifted its
coverage to western-trained
managers based in Hong Kong. It
cites occasions where hedge funds
would not reveal the identity of
fund backers or the background of
portfolio managers.
Compliance issue
The majority offshore Chinese
hedge funds are running from Hong
Kong and mainland China (Shanghai
and Shenzhen, with very few in
Beijing) entity. For Hong Kong
office, almost all of them are
Hong Kong Securities and Futures
Commission-registered.
"At the very beginning of the due
diligence process for investors
allocating to China hedge funds
investors should check to see if
the investment manager is
regulated, if the fund they manage
have independent directors, if the
fund is administered independently
by a well known firm, and if the
firm is audited independently by a
top grade auditor." Andy Mantel,
founder and CIO of Pacific Sun
Investment Management (HK) Ltd,
told to China Hedge by phone. Andy
is one of few offshore Greater
China hedge fund managers which is
non-Chinese but is fluent in
Mandarin due to his solid
financial background in the
Greater China Region for about 20
years. “Basically all mainland
headquartered hedge fund managers
fail this initial due diligence
test.”
Based on the statistics of China
Hedge Fund Managers (Onshore)
Database complied by China Hedge,
most of the mainland managers
(about 200 managers) are only
managing local Chinese hedge funds
denominated in RMB which are not
accessible by global investors.
Around 10% of them are running
offshore Greater China hedge funds
as well. Some have HKSFC-registered
operation. Only a few of them have
no HKSFC-registered operation
which may cause some compliance
issue.
Transparency and disclosure
issue
GFIA mentioned in its report that
those mainland-based managers are
the nature of "a lack of
fundamental transparency and
openness",
It is an issue in some
mainland-based fund managers that
they are not willing to disclose
their real holdings, and they do
not have a disciplined risk
management either, Kaikai Hua,
Director of Global Fund Desk in a
Shanghai-based wealth management
company, said in an interview with
China Hedge in Shanghai. “Normally
they have bet on one or two stocks
or PE investment, and cover big
loss or liquidity problem until
the stocks stop trading, or the
IPO fails.”
Before selecting China managers
for their US-based institutional
clients, Bill Hunnicutt strictly
required the Chinese managers must
be willing to accept complete
portfolio transparency which is
now mandatory post Madoff. Bill is
the President of Hunnicutt & Co.,
LLC which is a placement agency
based in the US. Bill said this
means showing a current portfolio
upon request. “Some larger US
institutions require daily
transparency via a dedicated
website, while others will accept
transparency via 3rd party vendors
who then provide a general summary
of the portfolio to the client.”
Business and cultural
difference
Cultural difference is quite
obvious between local managers and
global investors. Most local
managers are coming from mainland
mutual funds and securities firms.
They have the custom of running
local funds which may not be the
common standard set by global
investors. “If the local managers
do not tell you the companies they
hold because they do not want
others copy the idea. Knowing
something early than the market is
an important way for them to make
money", Kaikai said.
Language communication may also
cause some problem. Most local
managers are not comfortable to
communicate with and write in
English, thus, email reporting and
standard newsletter may not be
easily obtained from foreign
investors in a timely manner.
“They would rather not saying
anything than expressing something
wrong. It takes a while for
investors to fully communicate
with these managers.” Kaikai said.
It is the learning curve for
managers to know more about the
global practice and standard of
running a formal hedge fund.
Association may be a good channel
for those managers meeting
together regularly to share some
thoughts of running a hedge fund
business and draft practice for
participants to follow. Some
managers are knowledgeable the
market trend of increasing
allocation on China managers, thus
they recruit some Chinese partners
which are western-educated and/or
worked so that they can know more
about the standard requirement of
global investors.
Changing regulated status
The current Chinese law had put
Chinese mutual funds under
regulation but passed onshore
Chinese hedge funds. According to
the MarketWatch published by Citi
Securities and Investment Services
dated 17 December 2009, the mutual
fund law review workgroup, set up
by the China Securities Regulatory
Commission, has reached an
agreement to include
privately-raised funds as
regulated mutual funds in the
revised Mutual Fund Law.
Li, Zhenning, Chairman of Shanghai
Rising Fund Management and the
member of the mutual fund law
review workgroup suggested that
the regulator release licenses on
privately-raised funds (commonly
called local hedge funds) in the
future. Investors, thus, can
expect better regulation of local
hedge funds in areas such as
transparency issue and information
disclosure.
Comparative advantage of
Chinese-speaking CIOs
”Some local CIOs are sound
managers. They know what they are
doing, and what risk they face.
Despite lack of transparency and
no rigid risk control system,
mainland-based managers have a big
advantage that they know the
market well. They are more alert
to the growth engines in the
market, as well as problems in the
companies. They spend more time
talking to people in the street,
and ask what they think of a
product. It’s much easier for them
to access to companies too,”
Kaikai said.
To combine both HK and mainland
managers
“Hong Kong is by far the best
place to manage a China fund.
Aside from the unparalleled
infrastructure and regulatory
environment, the free flow of
instant, uncensored information is
vital when making investment
decisions.” Andy said. “Research
activities on the mainland can
only add value if it is a
supplementary research and
information gathering office in
support of the manager's
headquarters,” Andy emphasized.”
Western-trained managers based in
Hong Kong, Kaikai however mentioned, have
a different strategy. Most of
their holdings are big names and
liquid stocks. They perform better
in a bear market or when market is
in correction. And they have a
better understanding of tools for
hedging. “We see that one is a
stock picker, and the other one is
portfolio manager.” Kaikai
suggested clients to combine both,
so that they can fully enjoy the
growth of Chinese market.
Chinese hedge funds is growing
It is an irony case that China
hedge fund industry are becoming
more significant in the global
hedge fund sector. Many
institutional investors start to
monitor and even allocate China
hedge funds into their global
portfolio. “We should not neglect
the China market” is the common
belief of most global investors.
Market booming has helped the
industry asset size becoming
bigger and bigger. The industry
recorded an encouraging figure
last year. Chinese onshore hedge
fund managers had launched 242
products in 2009, according to a
report by Chengdu, Sichuan-based
Sinolink Securities Co Ltd. The
average size for every fund was
about 90 million yuan, the report
said. The 151 non-structured hedge
funds returned 54% on average in
2009. As the end of 2009, the
local China hedge fund industry
reached around RMB 50 billion.
Zhang Jianhui, Director of Fund
Research with Sinolink Securities,
said at the Sinolink Hedge Fund
Forum last Saturday in Beijing
that the hedge fund industry of
China would manage about RMB 100
billion as at the end of 2010.
CHINA HEDGE
(Please refer the related
article
at the issue of
29 January 2010
- Investment possibilities of
CHina onshore hedge funds: how to
choose a right manager)
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