Investing with China-based Hedge Funds: Problems and Solutions

February 14th, 2010
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Contributed by: Simon Kerr
This journal has been running for four months and this is the first posting to mention China. At the start of the year as strategists and economists gave outlooks for 2010 it was all about China. Anthony Bolton, after a career as a London-based fund manager at Fidelity dedicated to UK equities, has come out of retirement to run a Chinese equity fund and is to be based in Hong Kong. As a destination for investment, the popularity of China-focused funds is certainly on the rise. Sales of China-focused funds via Fidelity’s fund platform, FundsNetwork, increased by 59% in 2009, while sales into Fidelity’s China Focus Fund alone increased by 239%. That is how enticing China is as an investment destination. However, whilst there has been a China theme to many investment portfolios, and the largest hedge fund companies have opened Hong Kong or mainland China offices, Chinese dedicated hedge funds have been something of a side show in the hedge fund industry. This reflects that China is much more developed as a manufacturing centre than a service and financial centre.

So China is recognised as representing the largest global growth opportunity on a multi-year basis, but immature as far as the financial sector and capital markets are concerned. The Chinese equity markets represent a rich opportunity set, as do all frontier markets, but in this particular case, partly through cultural considerations, they can be difficult to access successfully and sustainably and with as much confidence in the execution as in the high concept. The practical difficulties were recently addressed by dedicated hedge fund site, using comments by GFIA as a springboard.

The rest of this post is in two parts: the article from Chinahedge, which has been re-written but not changed in shape or substance, and in part two a full, considered response from London-based Fund of Funds manager Caliburn Capital Partners, which targeted exposure to the China theme some years ago, and which has supported exposure in the region through a Singapore office.

Part One - The Problems

The investability of mainland China based managers has become an issue, as reflected in the decision by Singapore-based research firm GFIA to stop covering and investing in hedge funds based in mainland China. It has largely shifted its coverage to western-trained managers based in Hong Kong. As an example of the issues investors face it cites that on a number of occasions China-based hedge funds would not reveal the identity of fund backers or the background of portfolio managers.

Compliance issues

The majority of offshore Chinese hedge funds are run from Hong Kong and the mainland China cities of Shanghai and Shenzhen, with very few in Beijing. For those with a 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 China Hedge by phone. Andy is one of few offshore Greater China hedge fund managers who is non-Chinese but is fluent in Mandarin having been 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 operations which may cause some compliance issues.

Transparency and disclosure issue

GFIA mentioned in its report that those mainland-based managers show "a lack fundamental transparency and openness." It is an issue with 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, according to Kaikai Hua, director of a Shanghai-based wealth management company. He said, “normally they have a bet on one or two stocks or PE investments, and cover up the big loss or a 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.”

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