Hedge Fund Development in Hong Kong Group 4

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Hedge Fund Development in Hong Kong Group 4 034037 034080 034081 034082 034093 034108

Hedge Fund Development in Hong Kong Group 4 034037 034080 034081 034082 034093 034108 Chan Ching On (Peter) Wong Chi Hui (Sam) Wun Ho Chun (Calvin) Yuen Wai Keung (Gary) Chan Pun Kam (Kim) Chan Chun Fat (Eric /發)

Mutual Fund-Portfolio Theory l l l Long position; No derivatives and leverage Diversification of

Mutual Fund-Portfolio Theory l l l Long position; No derivatives and leverage Diversification of firm-specific risk Only subject to economy-wide risk l E. g. Tracker Fund 盈富基金 (Index Fund) Hang Seng Index ↑=Tracker Fund ↑ But HSI ↓= Tracker Fund ↓ Relative return (Correlation with market = 1) l I can be your Fund Manager! l l l ERIC

Hedge Fund l l l Absolute return (correlation with market=0) Marketneutral, no matter Bull

Hedge Fund l l l Absolute return (correlation with market=0) Marketneutral, no matter Bull or Bear Both long and short position; derivatives and leverage Return Highly depends on Fund Manager’s skill Solve Agency problem of fund manager: >invest their own wealth into the fund >performance-based commissions (may 20% of profit) Hedge Fund can be risky investment and subject to substantial loss ERIC

Hedge Fund Strategies l l l l Normal with short selling Technical (statistical, accounting,

Hedge Fund Strategies l l l l Normal with short selling Technical (statistical, accounting, historical data, compute modeling, mechanical) Event-driven (merger or convertible bond) Emerging market (BRIC 黃金四國) Distressed securities (big discounts due to reorganization/liquidation) Macro (global economies, govt. policies, interest rate, foreign currency, bond market, commodity) Fund of hedge funds ERIC

Hedge Fund Strategies Illustrated with Hong Kong examples SAM

Hedge Fund Strategies Illustrated with Hong Kong examples SAM

Market Neutral - Arbitrage Example: Tracker Fund V. S. Hang Seng Index Future SAM

Market Neutral - Arbitrage Example: Tracker Fund V. S. Hang Seng Index Future SAM

SAM

SAM

Hedge out most market risk by taking offsetting positions HSIF higher than HIS HSIF

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

Market Neutral – Securities Hedging Examples: 857 V. S. 386 941 V. S. 728

Market Neutral – Securities Hedging Examples: 857 V. S. 386 941 V. S. 728 330 V. S. 709 SAM

SAM

SAM

At point 1 (time 1) Buy 857, short sell 386 At point 2 (time

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 SAM

SAM

SAM

SAM

SAM

SAM

SAM

Designated Securities Eligible for Short Selling No. Stock Code Stock Short Name 1 1

Designated Securities Eligible for Short Selling 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* Listed by Stock Code Order (Effective: 1 March 2006) *Stock exempt from tick rule Source: http: //www. hkex. com. hk/tradi nfo/secshortsell/stkcdorder. htm SAM

In a Bear market SAM

In a Bear market SAM

Real example of Hedge Fund employing Macro Strategy 1992 Quantum Fund at London (Soros)

Real example of Hedge Fund employing Macro Strategy 1992 Quantum Fund at London (Soros) 1997 Financial Crisis in HK ERIC

George Soros (born August 12, 1930 in Budapest, Hungary as Schwartz Gyorgy) is a

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. ERIC

Black Wednesday l l ERIC 16 September 1992, Wednesday Soros became instantly famous when

Black Wednesday l l ERIC 16 September 1992, Wednesday Soros became instantly famous when he on behalf of Quantum Fund sold short more than US$10 bn 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↑)

Black Wednesday l l ERIC By 7 pm that evening, British government announced Britain

Black Wednesday l l ERIC By 7 pm 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

1997 Asia Financial Crisis l l ERIC From 1985 until July 2 nd 1997

1997 Asia Financial Crisis l l ERIC From 1985 until July 2 nd 1997 25 Thai baht = 1 US dollar An American hedge fund had already sold $400 million of the Thai currency, devaluing 56 Thai baht = 1 US dollar (>50% dropped) Thai stock market dropped 75% of value After the collapse of Thai baht, Malaysia, Indonesia, Hong Kong were also attacked by speculative pressure

HK ERIC

HK ERIC

1997 Asia Financial Crisis l l October 1997, 3 months after soveriegnty 7. 8

1997 Asia Financial Crisis l l October 1997, 3 months after soveriegnty 7. 8 HK dollars = 1 US dollars Macro strategy: borrow Thai baht from bank, say, borrow 1 billion baht at 25 baht: 1 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 50: 1→ repay half of its value profit = 50 -25 = 25, foreign exchange gain ERIC

ERIC

ERIC

HKMA has more than US$80 billion of foreign reserves, which is equivalent to 700%

HKMA has more than US$80 billion of foreign reserves, which is equivalent to 700% of M 1 ERIC The strong reserves make the market confident against any attack. HKMA sold US$1 billion to defend.

1997 Asia Financial Crisis l l l Apart from buying as much as HK$

1997 Asia Financial Crisis l l l 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% ERIC

ERIC

ERIC

1997 Asia Financial Crisis Best way of driving speculators away is making them lose.

1997 Asia Financial Crisis Best way of driving speculators away is making them lose. l 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) ERIC

Reasons of failure of hedge fund manager l l l ERIC Not mainly due

Reasons of failure of hedge fund manager l l l ERIC 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

Recent Development and Some Influence of Hedge fund CALVIN

Recent Development and Some Influence of Hedge fund CALVIN

Development of Hedge fund l l l Assets under management (AUM) in global hedge

Development of Hedge fund l l l Assets under management (AUM) in global hedge fund industry doubled from US$480 billion in 1999 to US$1 trillion in end-Sept 2005 Size is still small compared with traditional fund ↑interest in investors and fund house → sustain the growth CALVIN

Development of Hedge fund (con’t) l l l History of HK hedge funds is

Development of Hedge fund (con’t) l l l 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 US$12. 4 billion) 13 were retail hedge funds authorized by the SFC (AUM US$1. 2 billion) Biggest fund amount to more than US$500 million 6 are managed by SFC licensed managers ( totally US$830 million) CALVIN

Hedge fund news – TCL 2005 l l l TCI → The Children’s Investment

Hedge fund news – TCL 2005 l l l TCI → The Children’s Investment Fund Management (now have US$3 billion AUM) In late of Nov. 2005 → Link REIT’s 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 CALVIN

TCI l l l TCI acquire Link REIT → get 4 -5% interest? Want

TCI l l l TCI acquire Link REIT → get 4 -5% interest? Want ↑ Link’s 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 CALVIN

Some Influence of Hedge fund l l Authorized by SFC and should follow the

Some Influence of Hedge fund l l Authorized by SFC and should follow the SFC’s hedge fund guidelines SFC regularly review the guideline in order to protect the investor and make the development CALVIN

Some Influence of Hedge fund l l More people concern TCI (hedge fund) will

Some Influence of Hedge fund l l 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 >5% shareholding CALVIN

Regulation of Hedge Fund GARY

Regulation of Hedge Fund GARY

Regulation of Hedge Fund l l Authorized hedge funds are governed by the SFC's

Regulation of Hedge Fund l l Authorized hedge funds are governed by the SFC's Code on Unit Trusts and Mutual Funds. SFC authorization ≠ a seal of recommendation. GARY

Specific requirements on hedge funds l l l Fund managers’ qualifications Amount of assets

Specific requirements on hedge funds l l l 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 GARY

Fund managers’ qualifications l key personnel of fund managers of single hedge funds and

Fund managers’ qualifications l key personnel of fund managers of single hedge funds and Fund of Hedge Funds (Fo. HFs) 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 GARY

Amount of assets under management (AUM) l at least US$100 million AUM for fund

Amount of assets under management (AUM) l at least US$100 million AUM for fund manager of a single hedge fund or a Fo. HFs GARY

Risk management profile and internal control system l to commensurate with their business profile

Risk management profile and internal control system l to commensurate with their business profile and risk exposure, the fund managers should have: - proper, clearly written risk management - control procedures GARY

Appointments of representations and agents l l key parties, such as administrators, custodians and

Appointments of representations and agents l l 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 GARY

Growth of HK Hedge Fund Market KIM

Growth of HK Hedge Fund Market KIM

Growth of HK Hedge Fund Market l l Since May 2002, the Securities and

Growth of HK Hedge Fund Market l l 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 l l l KIM Single Hedge Fund of Hedge Funds Hedge Fund with a capital guarantee

Growth of HK Hedge Fund Market l l KIM The SFC also issues the

Growth of HK Hedge Fund Market l l KIM 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

Growth of HK Hedge Fund Market l l KIM In September, 2005, the SFC

Growth of HK Hedge Fund Market l l KIM 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

Growth of HK Hedge Fund Market l However, for the consideration the responses and

Growth of HK Hedge Fund Market l However, for the consideration the responses and the need to ensure investor protection, the SFC has decided that: l l KIM the minimum subscription of single hedge funds is maintained at US$50, 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

Demand from Hedge Funds KIM

Demand from Hedge Funds KIM

Demand from Hedge Funds l l l KIM The findings from a HKIFA survey

Demand from Hedge Funds l l l KIM 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 nonfund 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

Demand from Hedge Funds l l KIM This pattern also applies to banks and

Demand from Hedge Funds l l KIM 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

Demand from Hedge Funds KIM

Demand from Hedge Funds KIM

Demand from Hedge Funds l Reasons for the decreasing demand l l KIM Global

Demand from Hedge Funds l Reasons for the decreasing demand l l KIM Global equity markets have picked up since the latter part of 2003, which lead investors to return to the more traditional long-only products. S&P 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.

Trend of Development PETER

Trend of Development PETER

Trend of Development PETER l Lower minimum investment limit l More hedge fund-house launch

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

Recommendation PETER

Recommendation PETER

Recommendation l Lower minimum subscription amount l More clear and simple taxation l Balance

Recommendation l Lower minimum subscription amount l More clear and simple taxation l Balance of regulation l More promotion of hedge fund PETER

Conclusion

Conclusion

The End

The End