Trading from the viewpoint of Asian hedge funds

Fifteen years ago, the first influx of international hedge fund brands migrated to Asia. They came with a range of ambitions. Their plans included wanting to conduct research or even moving their night desks closer to oriental markets.

Fifteen years ago, the first influx of international hedge fund brands migrated to Asia. They came with a range of ambitions. Their plans included wanting to conduct research or even moving their night desks closer to oriental markets.

That move took place alongside the growth of the home grown hedge fund community. In 2015, we now see a second generation of home-grown managers springing up, with analysts and traders spinning out of existing hedge funds and setting-up new shops. These businesses come with existing investor relationships, a commitment to the region and portfolio management track records.

According to data firm Eurekahedge, the size of the Asian hedge fund industry currently accounts for assets under management of US$153 billion across 1,357 funds.

Heide Heiden-Blunt is the managing director and head of Asia Pacific for the Alternative Investment Management Association (AIMA), an industry group that represents the hedge fund sector in Asia and acts as a lobbying group on matters that affect the alternative investment sector.

“Launch sizes have increased in Asia and we are seeing a greater level of partnership between investors and hedge funds that can result in seeding and managed account deals or other support,” she says. “That gives managers additional comfort around launching. Asset sizes have to be larger as the barriers to entry have increased. Setting up a hedge fund now requires a much greater commitment in terms of resourcing. Quality Asian launches are now hitting capacity quickly, so it behoves investors to be involved earlier.”

Capacity has previously been a restrictive issue in Asian hedge funds. An investor writing a US$ 25 million ticket, does not usually want that investment to equal 50% of a US$50 million fund, but may be happy for that sum to be 10% of a $250 million fund. The smaller asset base of Asian managers in the past has meant that even if they were attractive in terms of risk/return they might not be so attractive in terms of the capacity they could offer.

“Capital raising is still a challenge today,” says Heiden Blunt. “Whilst risk-adjusted performance is a key driver of how to raise capital, hedge funds need to demonstrate significant operational and technical robustness. Investors are requesting more transparency around operations and strategy and third party risk aggregators are increasingly being used to maintain transparency on performance and elements of the portfolio.”

Trading specifics

In terms of sophistication, the trading abilities of hedge funds have increased and so have the demands of investors. A start-up hedge fund may be informed by a cornerstone investor that it has to find its own in-house trader after a certain period, in order to provide control and oversight, rather than permanently rely upon outsourced trading desks.

“If the trading ability of a fund is key to an investor, an investor will now expect a certain level of awareness and the trading sophistication around that function,” says Heiden Blunt. “There is a higher level of understanding of the metrics, the pre-and post-trade analytics that enable better judgment of the trader’s contribution to the strategy. Automation and the analytical tools that exist now allow for better transparency – not just for trader and fund, but between fund and counterpart, or even fund and investor.”

In terms of the talent, trading skills already proliferate widely in the hedge fund sector, unlike disciplines such as compliance, where there are more unfilled vacancies.

“Where trading is important to your strategy, then a trader would likely have been one of your core staff at the inception of your fund,” she says. “What has changed in the trading space is the sophistication of trading systems, the way managers can slice and dice information, the interconnectivity between e trading and order management systems and the formal books and records –having a better understanding of front-to-back flow and capturing all the data points that are critical.”

From a trading perspective, automation and systems are where there has been the most development for hedge funds during the recent past. That has been reflected in some of the service providers that have been coming into the market.

“There were fewer options six years ago; either less flexible solutions for start-ups, or highly customisable tools for larger houses – but which start-ups couldn’t afford,” she says. “but now we have a breadth of service providers which allows better coverage to any fund, irrespective of his trading sophistication or asset size.”

She added that the systems implemented from day one and the data that they contain can be difficult to change further down the line. A hedge fund manager and his trader need to have an eye on what is scalable for the way in which the fund develops.

Cross-industry collaboration

A year and a quarter have passed since Hong Kong introduced its electronic trading rules. The regulations that were devised by Hong Kong’s regulator, the Securities and Futures Commission (SFC), resulted in buy- and sell-side firms being called upon to commit to large scale projects to vouchsafe their use of algorithms.

That compliance functionality required due oversight over how orders entered and impacted the markets and that all elements of that trading process were understood and compliant. It was a big task for firms, even for those that possessed significantly larger resources than local hedge funds.

AIMA took a proactive approach to helping the buy-side, collaborating with other industry bodies in order to produce an information template.

‘We regarded the template as a success. The rules were principles-based in some places and prescriptive in others,” says Heiden-Blunt. “It was apparent that the buy- and sell-side were going to need to collaborate to come up with the appropriate level of transparency for everyone involved, and meet the SFC’s requirements. The discussions that went on played a great part in process and function and stimulating discussions around best practice, as well as highlighting where there was a gap in understanding of one another’s businesses.”

Individual hedge fund managers could evaluate the template against their own e-trading usage and supplement it with further questions for their providers to answer. Answers were provided to a level of transparency that enabled analysis and record keeping of a broker’s processes and allowed comparisons between providers to be made.

The endgame for AIMA members is that what started out being an extremely large piece of regulation became an industry dialogue resulting in a practical solution, making implementation easier to digest.

“Hedge funds have a robust timetable of their compliance review processes and electronic trading is now firmly part of that calendar,” says Heiden Blunt. “Also, where people had multiple algos and were perhaps only using four or five, a streamlining process took place whereby funds evaluated them, preserved the ones they had been historically using, and perhaps turned the others off.”

Today, as a follow-on from those regulations, there is a more direct conversation about developments on the sell-side – which is now required to keep the buy-side apprised of material changes to algorithms. Since the sell-side is now having to both train and inform, it means that there is more of a cognisance among the providers of which algorithms are being used most and that probably aids their development of new products.

Stock connect

The Shanghai-Hong Kong Stock Connect has been an attractive innovation for the local hedge fund industry. One reason for that is because hedge funds do not own their own Qualified Foreign Institutional Investor (QFII) quota, they source it from larger sell-side institutions. With the Stock Connect, there is no requirement for quotas or licenses, making it easier for hedge funds.

“People who already have an interest in China now have another pipe to access the country and we’d like to see a continued opening up and evolution of the initiative,” she says. “Hedge funds are actively using the Stock Connect, although I haven’t come across funds who now invest in China just because of Stock Connect itself. The authorities have been willing to engage with the industry and a lot has been achieved in a short space of time.”