By Robert Cookson
Published: May 23 2010 13:21 | Last updated: May 23 2010 13:21
On the Hong Kong trading floor of LIM Advisors, one of Asia’s oldest hedge fund managers, lies a large blue inflatable ball, the type commonly found in yoga studios. It is where George Long, who founded the firm in 1995, chooses to sit when he wants to discuss strategy with colleagues and take the pulse of the markets.

Over the past decade and a half, Mr Long, who is also chief investment officer and chairman, has navigated a series of savage boom-bust cycles and witnessed assets under management in Asia’s nascent hedge fund industry grow to about $120bn (£84bn, €98bn).

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Now, in the wake of the global credit crunch, he believes the industry is undergoing its most profound shake-up since the 1997 Asian financial crisis, which unleashed devastation across the region.

“The 2008 crisis was a watershed because a lot of hedge funds globally – and in Asia especially – were proven not to be hedge funds,” he says.

“If you’re down 50/60 per cent, you’re not a true hedge fund.”

Traditionally, most Asian hedge funds have done little more than ride momentum in the equity markets, using leverage to amplify returns but failing to hedge their positions – meaning they have been periodically crushed by downturns.

“The crisis showed that a lot of the hedge funds out here were pure beta players,” Mr Long says.

Indeed, as markets crashed during the crisis and investors withdrew money, assets under management in the Asian hedge fund industry dropped from a peak of $173bn in June 2008 to an estimated $117bn this month, according to data provider Eurekahedge .

Meanwhile, under pressure from clients, a number of funds have started to offer cheaper alternatives to the classic “2 and 20” fee structure (2 per cent of assets under management and 20 per cent of portfolio returns) that prevailed before the crisis.

Big institutional investors are so disillusioned with the performance of Asia’s long-short equity hedge funds that they are switching to cheaper options such as exchange traded funds, fundamental long-only managers, and even index futures, Mr Long says.

All that is for the good, he believes, as it will force the hedge fund ecosystem in Asia to become more skill-based and diverse.

“You’ll see macro hedge funds in Asia, you’ll see market neutral hedge funds, you’ll see volatility trading hedge funds and other multi-strategy funds like us,” he forecasts.

For its part, LIM Advisors seeks to generate absolute returns through non-directional strategies such as convertible bond arbitrage, merger arbitrage, and relative value trades – for example between Hong Kong H shares and Shanghai A shares.

At the core of the firm’s strategy is a conviction that generating steady compounding returns will ultimately triumph over more volatile strategies. The LIM Asia Multi-Strategy Fund, the firm’s flagship fund with about $800m under management, has recorded an annualised return of 9 per cent per year since its inception in 1996.

“In a strong year for equities, we’ll perform about average. But in a down year we’ll really shine,” he says.

In 2006 and 2007, ahead of the financial crisis, Mr Long took advantage of his background as a credit analyst by placing a number of bets against a financial meltdown. In one of his more prescient trades, he took short positions in US subprime mortgages by investing in a number of structured credit funds that needed to refinance their synthetic collateralised debt obligations.

“If you’re trying to hedge your risk, you want to short the cheapest instrument. Shorting US synthetic mortgages was very cheap,” he recalls.

Yet the hedges were not enough to stop the fund losing 14 per cent in 2008, its only annual loss apart from a 6 per cent dip in 1997.

Besides an emphasis on low leverage, Mr Long puts the firm’s longevity down to a rigorous approach to risk management that was forged during the Asian financial crisis more than a decade ago. “The most important lesson we learnt in 1997/98 was that prime brokers’ leverage is unreliable. The whole system is fragile,” he says. “We also learnt that market makers can freeze and drop out.”

At the start of the Asian crisis there were about 30 institutions making markets in convertible bonds, he recalls – but only two of them were still there at the bottom of the market in 1998. History repeated itself in 2008, when a procession of market makers shut down and some brokers stopped accepting convertible bonds as collateral.

As a result of these experiences, and in contrast to many of its peers in the region, LIM Advisors seeks to protect itself from shocks by using six prime brokers as well as a separate custodian bank, HSBC.

“Low leverage and having diversified counterparties has allowed us to be very flexible,” he says.

Flexibility will be crucial if, as Mr Long predicts, the Asian asset management industry – and hedge funds in particular – experiences explosive growth over the coming years.

“In Asia, we have high savings rates, current account surpluses, so wealth is building up here, and that supports an asset management industry in a very big way.”

One of the most significant trends underway, he believes, is that Asian investors are emerging as some of the world’s biggest allocators of capital.

That will spur the development of the local hedge fund industry as well as attracting more and more western managers to set up shop in the region.

Increasingly punitive tax regimes in the west will accelerate the trend, he reckons.

“Ten years ago you had to get money from London, New York or Switzerland. Now you can get local [Asian] capital. That’s a big switch and that will get bigger over time.”

At the moment, things are still moving slowly. While capital is again being allocated to hedge funds in the region, investors are more cautious about where they put their money.

It can now take institutional investors as long as a year to conduct due diligence on a fund before they finally hand over the money, Mr Long says.

Not that he is in a rush. Mr Long says he wants to expand in a moderate fashion, unlike the giant US and European hedge fund “marketing machines” that are setting their sights on Asia.

“We don’t want to go from a billion to five billion overnight – that’s a recipe for disaster.”

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