Ex-Pimco Palghat to Double Assets in Fixed-Interest Hedge Fund

Date: Monday, July 20, 2009
Author: Candice Zachariahs and Malcolm Scott, Bloomberg

Kapstream Capital, Australia’s biggest fixed-income hedge fund, will almost double assets under management in the next month as pension funds seek returns in all market conditions.

The Sydney-based firm has secured investments that will take funds it oversees to A$1.2 billion ($965 million), from A$650 million, said founder Kumar Palghat, Pacific Investment Management Co.’s former head of portfolio management in Asia- Pacific. He aims to raise A$1.5 billion by end-2009 as investors switch to managers that made money even as global markets tumbled last year.

“People are recognizing that there are some opportunities in the credit space and they are more willing to start investing in them now,” said Robert Dasilva, managing director of Asia- Pacific fixed income in Sydney at Principal Global Investors, which manages $228 billion in assets globally.

Kapstream is tapping rising demand for fixed interest investments in Australia after the global market rout led to a 41 percent slide in the S&P/ASX 200 Index last year. Australians have more than A$200 billion in credit investments, or almost 20 percent, of the total A$1.169 trillion in managed funds, according to government data.

Pimco, adviser to the world’s largest bond fund, and BlackRock Inc., the world’s biggest asset manager, oversee a combined 31 percent of the fixed-income funds in Australia, according to data from Rainmaker Group, a Sydney-based researcher of pension funds and investment managers. They are the two biggest international fixed-income managers in Australia, according to Rainmaker.

‘Plenty of Money’

Palghat started Kapstream in 2007 after working for Pimco from 1997 to 2006, where he helped manage A$22 billion as head of investment for Asia-Pacific.

He said he’s not competing with his former employer or BlackRock just yet, telling clients they should allocate to his alternative strategy alongside traditional bond funds.

“In Australia, there’s plenty of money but not enough assets to buy,” Palghat, 48, said in an interview on July 17. “In this space, you have to be global.”

The new investments come from local pension funds, Palghat said without naming them. Kapstream will have 10 to 12 investors after the new money comes in, and is starting to offer its funds to individual investors via Challenger Financial Services Group Ltd. to diversify the client base.

Hedge funds, beset by investor withdrawals in 2008, had net inflows for the second straight month in June, when they lured $4 billion, according to Singapore-based data provider Eurekahedge Pte.

Post-Crisis Inflow

Kapstream currently offers the Absolute Return Income Fund and manages separate client accounts invested in sovereign and government-guaranteed debt. The fund returned 7.35 percent in 2008, compared to an average 10.9 percent loss by Australian fixed-income funds as measured by Australian Fund Monitors, which covers about 200 Australian-based hedge funds.

“In 2009, people are finally saying ‘okay I got through the crisis, now I’m going to look at my asset allocation and I’m going to get rid of managers that didn’t save me during the crisis,’” Palghat said.

Among fixed-income hedge funds monitored by AFM, the QIC Global Fixed Interest Alpha Fund, with A$224 million under management, posted the best performance over the 12 months to May, returning 15 percent. Kapstream’s fund is up 7.2 percent over the same period.

Diversification

The Absolute Return Income Fund, with about A$400 million in assets now, is 60 percent to 70 percent invested in corporate debt including Pfizer Inc., Philip Morris International Inc. and H&R Block Inc. Palghat said he’s adding to the portfolio of Australian bank subordinated debt by buying bonds issued outside the country.

Another 20 percent of the fund is invested in cash and liquid assets including bank bills and government-guaranteed notes. Mortgages make up the remaining 10 percent to 15 percent.

Kapstream favors holding AA-rated corporate debt with yields between 7 percent and 9 percent and is diversifying away from the Australian market toward a portfolio invested equally in the U.S., Australia and Europe, Palghat said. The average spread for U.S. AA-rated corporate bonds over government debt was 206 basis points as of July 16, according to a Merrill Lynch & Co. index.

Asia Fund

Once corporate debt spreads narrow and interest rates rise, Kapstream may offload its holdings of the securities in favor of government bonds or inflation-indexed debt, said Palghat.

The fund targets annual returns between 7.5 percent and 8 percent, isn’t leveraged, and charges a 0.4 percent management fee, or 0.2 percent plus a performance fee.

As well as buying debt, Kapstream takes positions in futures and options markets to negate duration risk or profit from relative value trades, Palghat said.

Palghat is considering starting an Asia-focused offering in coming years, seeking to tap into the world’s fastest economic growth rates. While no firm plans are in place for an Asian fund, Palghat said he has hired people to research the region.

“Macroeconomically I’m very bullish on Asia,” he said.

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net; Malcolm Scott in Sydney at mscott23@bloomberg.net