Hedge funds face the heat

Date: Monday, January 26, 2009
Author: Nesil Staney, Livemint.com

Every morning, there is at least one hedge fund shutting down in Asia,” says Daniel McCormack, equity strategist at Australian financial house Macquarie Capital Securities Ltd.After a year of dismal returns that has seen the industry shrink by one-fifth to $1.5 trillion, or Rs73.8 trillion, and many funds shutting shop, shell-shocked investors, often well heeled, are globally yanking cash out of hedge funds, lightly regulated pools of capital that take bets on all sorts of global assets—equities, bonds, commodities and currencies—in complex trading strategies often backed by even more complex mathematical models.

In India, such country-focused funds were among the worst hit in Asia last year. The combined assets of around 70 hedge funds aimed at India have decreased by at least two-thirds in 2008, according to about 15 client brokers and hedge fund managers in Mumbai Mint interviewed for this story.

Hedge funds are part of the so-called shadow banking system that exists outside the range of regulatory oversight; they are secretive and do not report fund size (often leveraged several times through debt) and returns to outsiders.

Mint could not independently confirm this estimate of portfolio losses, but evidence of investor withdrawals and funds folding up dot the hedge fund landscape here.

UK-based Clareville Capital Partners Llp. closed its office on the 11th floor of Bajaj Bhavan at Nariman Point, Mumbai’s business district, late last year. Its India fund manager, Krish Shanbhag, now heads equity research at local start-up institutional brokerage, Antique Stock Broking Ltd.

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Boyer Allen India Fund, too, was liquidated in end-2008. US-fund Hudson Fairfax Group Llc., focusing on real estate, closed its India operations around the same time.

Another multibillion dollar UK hedge fund, The Childrens Investment Fund Foundation, or TCI, has been winding down its investments in India—banks dominated its portfolio—after its French fund manager, Patrick Digorse, left. TCI’s Indian stock portfolio was worth at least $1.2 billion in early 2008.

The British activist fund had earlier parted ways with its Indian joint venture partner Madhav Bhatkuly, former country partner at Singapore-based fund Arisaig Partners Pte Ltd and a board member at local brokerage Motilal Oswal Financial Services Ltd.

“Funds remain bearish on India as they expect corporate earnings to remain low, with the huge inventory pile-up in China and demand destruction in the developed world,” said Bhatkuly, who now runs another hedge fund New Horizon Investments.

Comments were sought from TCI for this story, but it did not respond. Launched in 2003 by money manager Christopher Hohn, TCI made its local reputation as an activist fund when it wrote to local stock market regulator, Securities and Exchange Board of India, or Sebi, to protest the complex restructuring plan of metals tycoon Anil Agarwal’s Vedanta Resources Plc.

Large India-dedicated hedge funds, including Monsoon Capital Llc. and US-based Sansar Capital Management Llc., are battling huge redemptions and a slump in their asset values in 2008. According to brokers, some of these funds may wind down operations. Sameer Arora’s Helios Capital Management, which had assets worth $1.2 billion at the end of 2007, now manages about $300 million.

Helios is not the only fund that has seen a sharp erosion in value. French investor Shanti Asset Management’s largeIndia-dedicated fund lost at least 70% in 2008. Another large India-dedicated fund, Eaton Vance Greater India Fund, lost 65%, say industry insiders.

Other India-dedicated funds—including Aberdeen Global Indian Equity Fund, Arisaig India Fund, Matthews India Fund, Pictet Funds Indian Equities, WisdomTree India Earnings, Nomura India Equity Fund, Melchior Selected Trust, Indian Opportunities Fund, Schroder ISF Indian Equities, Excel India Fund and CAAM Funds India—have all seen at least 60% value erosion from 2008.

To be sure, between January and December, Indian equity makets measured by the Bombay Stock Exchange’s benchmark Sensex lost 52% in value after a sevenfold rise between 2003 and early 2008.

The largest foreign institutional investor, or FII, in India, Halbis Capital Management, an arm of Hong Kong and Shanghai Banking Corp. Ltd, or HSBC, managed by celebrity fund manager Sanjiv Duggal and team, saw assets decline from about $8 billion around the end of 2007 to about $2 billion by end-2008. One of its key fund managers, Manish Srivastava, has joined local brokerage India Infoline Ltd.

Several large hedge funds, including Tudor Investment Corp., Lloyd George Management, Farallon Capital Management Llc., Raj Mishra’s Indea Capital Pte Ltd, Tree Line Investment Management Ltd, Arshad Zakaria’s New Vernon Capital Llc., each had India portfolios worth upwards of $1 billion, which are now down to a few hundred million dollars, said several client brokers who refused to be named, fearing disruption in business relationships.

Mint could not seek or receive comment from all of the funds named in this story.

Indian regulators, who had been worried about the wave of hedge-fund money that splashed into Indian stocks in 2007, are likely to take a sigh of relief as longer-term foreign investors grow in importance because of the ebbing of hedge-fund money.

“Leveraged hedge funds and leveraged investors, who were investing in India funds, all had to perforce sell when the asset value went down,” Sebi chief C.B. Bhave said in an earlier interview.

FIIs pulled out around $13 billion, net of investments, from Indian equities during 2008, which also saw 454 new FII registrations.

“It may now take many years for us to start earning the carry,” said a Mumbai-based hedge fund executive with a large India-focused fund, explaining why hedge fund executives are quitting jobs.

Carry is hedge-fund-speak for the difference between the rate at which money is borrowed and the rate at which it is invested.

Hedge fund managers typically take home 2% management fee and 20% of the annual profits of their funds.

With their fund units down to one-fifth and one-sixth of their value in 2007, it will take several years of outstanding performance or returns for these fund units to make profits, and thus make hedge fund executives eligible for such carry fee.

Amid the slowdown and gloom, a few large global hedge funds such as Capital International Asset Management and Janus Capital Group Inc. continue to be active in the Indian market, according to a senior executive of a large domestic brokerage, which also offers arbitrage products to hedge funds.

“Capital International is the most respected hedge fund in (the) Indian market. It can swing the market (either way),” said the head of equity capital markets at a large foreign investment bank.

George Soros’ Quantum Fund, which played contrarian, picking up significant stakes in many large Indian stocks, including Anil Ambani’s Reliance Capital Ltd, Anand Jain’s Jai Corp. Ltd and two Indiabulls entities, in 2008, is now selling. On Wednesday, it sold more than 2% stake in Reliance Capital, the company said in an announcement to the Bombay Stock Exchange.

nesil.s@livemint.com