Hedge Fund Development in Hong Kong

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Hedge FundDevelopment inHong Kong

• Group4
• 034037 Chan Ching On (Peter)
• 034080 Wong Chi Hui (Sam)
• 034081 Wun Ho Chun (Calvin)
• 034082 Yuen Wai Keung (Gary)
• 034093 Chan Pun Kam (Kim)
• 034108 Chan Chun Fat (Eric /?)

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Mutual Fund-Portfolio Theory

• Long position No derivatives and leverage
• Diversification of firm-specific risk
• Only subject to economy-wide risk
• E.g. Tracker Fund ???? (Index Fund)
• Hang Seng Index ?Tracker Fund ?
• But HSI ? Tracker Fund ?
• Relative return (Correlation with market 1)
• I can be your Fund Manager!

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Hedge Fund

• Absolute return (correlation with market0)
  Market-neutral, no matter Bull or Bear
• Both long and short position derivatives and
  leverage
• Return Highly depends on Fund Managers skill
• Solve Agency problem of fund managergtinvest
  their own wealth into the fundgtperformance-based
  commissions (may 20 of profit)
• Hedge Fund can be risky investment and subject to
  substantial loss

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Hedge Fund Strategies

• Normal with short selling
• Technical (statistical, accounting, historical
  data, compute modeling, mechanical)
• Event-driven (merger or convertible bond)
• Emerging market (BRIC ????)
• Distressed securities (big discounts due to
  reorganization/liquidation)
• Macro (global economies, govt.policies, interest
  rate, foreign currency, bond market, commodity)
• Fund of hedge funds

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Hedge Fund Strategies

• Illustrated with
• Hong Kong examples

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Market Neutral - Arbitrage

• Example
• Tracker Fund
• V.S.
• Hang Seng Index Future

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Hedge out most market risk by taking offsetting
positions
HSIF higher than HIS HSIF lower than HSI
short HSIF long HSIF
Long Tracker Fund short sell Tracker Fund
at the same time and equal amount at the same time and equal amount
Profit is made on the HSI future settlement day when selling all the contracts (on the 2nd last trading day of the month) Profit is made on the HSI future settlement day when selling all the contracts (on the 2nd last trading day of the month)
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Market Neutral Securities Hedging

• Examples
• 857 V.S. 386
• 941 V.S. 728
• 330 V.S. 709

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At point 1 (time 1) Buy 857, short sell 386
At point 2 (time 2) Buy back 386, sell 857
at the same time and equal amount
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Designated Securities Eligible for Short Selling

• Listed by Stock Code Order
• (Effective 1 March 2006)
• Stock exempt from tick rule
• Source http//www.hkex.com.hk/tradinfo/secshortse
  ll/stkcdorder.htm

No. Stock Code Stock Short Name
1 1 CHEUNG KONG
5 5 HSBC HOLDINGS

156 728 CHINA TELECOM
105 386 SINOPEC CORP
152 709 GIORDANO INT'L
250 2800 TRACKER FUND
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In a Bear market
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Real example of Hedge Fund employing Macro
Strategy

• 1992 Quantum Fund at London (Soros)
• 1997 Financial Crisis in HK

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• George Soros (born August 12, 1930 in
  Budapest, Hungary as Schwartz Gyorgy) is a
  financial speculator, stock investor,
  philanthropist, liberal political activist and
  philosopher. He is currently the chairman and
  founder of Soros Fund Management. In 1970 he
  co-founded the Quantum Fund with Jim Rogers. It
  returned 3,365 during the next ten years, and
  created the bulk of the Soros fortune.

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Black Wednesday

• 16 September 1992, Wednesday
• Soros became instantly famous when he on behalf
  of Quantum Fund sold short more than US10bn
  worth of pounds
• Bank of England has ever raised interest rate
  from 10 to 12 (?8 x 25 points) to defend by
  attracting buyer of pounds
• (Interest rate?, Investment?, Property market?,
  Stock market?, Spending?Unemployment rate?)

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Black Wednesday

• By 7pm that evening, British government announced
  Britain would leave the ERM (European Exchange
  Rate Mechanism) and to devalue the pound
  sterling, and Soros earned an estimated US 1.1
  billion in the process
• Government lost and Hedge Fund won

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1997 Asia Financial Crisis

• From 1985 until July 2nd 199725 Thai baht 1 US
  dollar
• An American hedge fund had already sold 400
  million of the Thai currency, devaluing56 Thai
  baht 1 US dollar (gt50 dropped)
• Thai stock market dropped 75 of value
• After the collapse of Thai baht, Malaysia,
  Indonesia, Hong Kong were also attacked by
  speculative pressure

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HK
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1997 Asia Financial Crisis

• October 1997, 3 months after soveriegnty7.8 HK
  dollars 1 US dollars
• Macro strategyborrow Thai baht from bank, say,
  borrow 1 billion baht at 25 baht1 dollar, sell
  Thai baht in the market until devaluation,get
  US from Thai reserve at bank,buy devalued Thai
  baht, say, 50 baht 1 dollar,repay 1 billion
  baht at 501? repay half of its valueprofit
  50-25 25, foreign exchange gain

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HKMA has more thanUS80 billion of foreign
reserves, which is equivalent to 700 of
M1 The strong reserves make the market confident
against any attack. HKMA sold US1 billion to
defend.
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1997 Asia Financial Crisis

• Apart from buying as much as HK from the
  speculators, another defending measure adopted by
  HKMA and Donald Tsang (Financial Secretary at the
  time) include at August 15, 1998,overnight
  interest rate ? from 8 to 23 (at a point, 500)
• Interest rate ?, stock market collapse, hedge
  fund can profit from short selling
• Between 20 and 23 October, Hang Seng Index dipped
  by 23

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1997 Asia Financial Crisis

• Best way of driving speculators away is making
  them lose.
• Thus, HK govt. declared war with speculators
  openly, entered stock market and bought shares
  being shorted and Hang Seng Index Futures
  contract
• (in 2001, HK govt. left the market by
  establishing Tracker Fund)

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Reasons of failure of hedge fund manager

• Not mainly due to HK govt tactics
• But default payment of Russian Govt. Bond and the
  collapse of LTCM, making contraction of hedge
  fund activities such as leverage with margin
  lending
• As a result, hedge fund attacks on Asia financial
  system closed

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Recent Development and Some Influenceof Hedge
fund
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Development of Hedge fund

• Assets under management (AUM) in global hedge
  fund industry doubled from US480 billion in 1999
  to US1 trillion in end-Sept 2005
• Size is still small compared with traditional
  fund
• ?interest in investors and fund house ? sustain
  the growth

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Development of Hedge fund (cont)

• History of HK hedge funds is so short
• HK is one of the place in the world to allow the
  sale of hedge fund to retail public I 2002
• At end 2004 ? 113 hedge funds operating in HK
  (AUM to US12.4 billion)
• 13 were retail hedge funds authorized by the SFC
  (AUM US1.2 billion)
• Biggest fund amount to more than US500 million
• 6 are managed by SFC licensed managers ( totally
  US830 million)

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Hedge fund news TCL 2005

• TCI ? The Childrens Investment Fund Management
  (now have US3 billion AUM)
• In late of Nov. 2005 ? Link REITs trading volume
  increase suddenly
• Some FI suspect some Hedge fund hold more than 5
  shareholding
• 1 Dec. ? TCI hold 383.724 million units (17.95)
  of trust.
• However, they only acquire 0.41 in IPO

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TCI

• TCI acquire Link REIT ? get 4-5 interest?
• Want ? Links debt ratio (debt to asset ratio) ?
  borrow from outside ?pay to holder
• Link have 34 billion total asset 12.2 billion
  debt
• Link can borrow more 3.2 billion ? pay extra 1.5
  to each unit
• TCI can make a high revenue

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Some Influence of Hedge fund

• Authorized by SFC and should follow the SFCs
  hedge fund guidelines
• SFC regularly review the guideline in order to
  protect the investor and make the development

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Some Influence of Hedge fund

• More people concern TCI (hedge fund) will make
  some unreasonable demand on Link and other REITs
• SFC disclosure requirement ? REITs is not the
  same as other listed co.
• Dec. 2005 ? SFC change their policy on disclosure
  requirement
• Now request all listed REITs need to disclose gt5
  shareholding

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Regulation of Hedge Fund
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Regulation of Hedge Fund

• Authorized hedge funds are governed by the SFC's
  Code on Unit Trusts and Mutual Funds.
• SFC authorization ? a seal of recommendation.

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Specific requirements on hedge funds

• Fund managers qualifications
• Amount of assets under management (AUM)
• Risk management profile and internal control
  system
• Appointments of representations and agents
• Performance fee
• Information disclosure and other structural
  measures

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Fund managers qualifications

• key personnel of fund managers of single hedge
  funds and Fund of Hedge Funds (FoHFs) must have
  - a minimum of 5-year general experience in
  managing hedge funds, - at least 2 years of
  which is specific to the particular strategy
  applied in that hedge fund

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Amount of assets under management (AUM)

• at least US100 million AUM for fund manager of a
  single hedge fund or a FoHFs

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Risk management profile and internal control
system

• to commensurate with their business profile and
  risk exposure, the fund managers should have-
  proper, clearly written risk management -
  control procedures

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Appointments of representations and agents

• key parties, such as administrators, custodians
  and prime brokers must have sufficient competence
  in their own areas
• the fund managers also need to provide adequate
  information and training to their selling agents

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Growth of HK Hedge Fund Market
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Growth of HK Hedge Fund Market

• Since May 2002, the Securities and Futures
  Commission (SFC) issued the guidelines on Hedge
  Fund for its authorization and they were
  effective
• SFC divided Hedge Fund into 3 categories
• Single Hedge Fund
• Fund of Hedge Funds
• Hedge Fund with a capital guarantee

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Growth of HK Hedge Fund Market

• The SFC also issues the Guidelines on Hedge Funds
  Reporting Requirements for the details regarding
  hedge funds on-going reporting obligations
• The Circular to Registered Persons Regarding the
  Marketing of Hedge Funds to remind financial
  intermediaries of their obligations to assess

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Growth of HK Hedge Fund Market

• In September, 2005, the SFC announced new hedge
  fund guidelines and effective immediately
• The SFC published its conclusions on the
  Consultation Paper on the Review of the Hedge
  Fund Guidelines

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Growth of HK Hedge Fund Market

• However, for the consideration the responses and
  the need to ensure investor protection, the SFC
  has decided that
• the minimum subscription of single hedge funds is
  maintained at US50,000
• There will not be a relaxation of the current
  restriction imposed on the level of
  collateralisation to prime brokers for
  SFC-authorised hedge funds

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Demand from Hedge Funds
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Demand from Hedge Funds

• The findings from a HKIFA survey indicate that
  whilst there is latent demand for this type of
  products
• The early adopters probably are the more seasoned
  investors, one out of five fund investors (about
  21 of the respondents) would consider investing
  in hedge funds.
• As expected, the percentage is much lower for
  non-fund investors only about 2.
• The most common reason for not buying is
  unfamiliarity.
• Experience from overseas markets indicates that
  the early adopters are usually the more informed
  and sophisticated investors

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Demand from Hedge Funds

• This pattern also applies to banks and other
  distributors, which account for over 90 of fund
  sales in Hong Kong.
• This is usually supplemented by a series of very
  thorough training initiatives so as to ensure
  that the sales processes are properly conducted
• The investment strategies of hedge funds are more
  diverse than the traditional mutual fund products
• Also, they generally require much more time and
  resources for education and for communication
  with the staff and investors

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Demand from Hedge Funds
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Demand from Hedge Funds

• Reasons for the decreasing demand
• Global equity markets have picked up since the
  latter part of 2003, which lead investors to
  return to the more traditional long-only
  products.
• SP Investment Performance Measurement Report
  indicates that for the year of 2004, hedge funds
  managed by HKIFA members registered an average
  return of 8.8, lower than the average return of
  27.3 for the full year of 2003.

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Trend of Development
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Trend of Development

• Lower minimum investment limit
• More hedge fund fund-house launch office at Hong
  Kong because of Qualified Domestic Institutional
  Investor (QDII)

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Recommendation
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Recommendation

• Lower minimum subscription amount
• More clear and simple taxation
• Balance of regulation
• More promotion of hedge fund

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Conclusion
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The End