EVOLUTION AND TRENDS IN ASIA’S HEDGE FUND INDUSTRY Paul Smith, CFA Managing Director, Asia Pacific

TABLE OF CONTENTS

2

1. Current state of Asia’s hedge fund industry

2. Global hedge fund industry 3. Challenges & outlook

4. Distressed asset investing and special situations

ASIAN HEDGE FUNDS

Classic hedge fund structure: • Open-ended company • Domiciled in the Cayman Islands, Luxembourg, Dublin,

BVI and similar jurisdictions • Corporate governance compliance – independent

directors, independent fund administrators, independent auditors, etc.

• Monthly or quarterly dealing • Heavy equity orientation • Directional

3

ASIAN INDUSTRY CHARACTERISTICS

• Low barrier to entry • About 1,000 funds, managing $138 billion; peaking at

$200 billion • 40% have only $25 million under management • Mainly in Hong Kong & Singapore (Japan has collapsed) • China has huge hedge fund industry • Increasing regulation • Growth of homegrown talent

4

5

SOURCE: GFIA

6

THE GLOBAL FINANCIAL CRISIS

7

THE GLOBAL FINANCIAL CRISIS

8

$38,910 $58,370

$95,720 $167,790

$167,360

$185,750 $256,720

$367,560 $374,770

$456,430 $490,580

$539,060 $625,554

$820,009

$972,608

$1,105,385

$1,464,526

$1,868,419

$1,407,095

$1,600,156

$1,917,385 $2,008,065

$2,252,378

$8,463 $27,861 $36,918

($1,141)

$14,698 $57,407

$91,431

$4,406

$55,340

$23,336 $46,545

$99,436

$70,635 $73,585

$46,907

$126,474 $194,515

($154,447)($131,180)

$55,464 $70,596 $34,433

($500,000)

($250,000)

$0

$250,000

$500,000

$750,000

$1,000,000

$1,250,000

$1,500,000

$1,750,000

$2,000,000

$2,250,000

$2,500,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Asse

ts ($

MM

)

Estimated Assets Net Asset Flow

GLOBAL HEDGE FUND – GROWTH OF ASSETS/NET ASSET FLOW

SOURCE: HFR Q4 2012 REPORT

GLOBAL FOHF – GROWTH OF ASSETS/NET ASSET FLOW

9

$1,898 $19,902

$36,797

$75,413 $74,592

$56,347 $52,525 $74,033

$75,783 $76,094

$83,535 $102,546

$206,937

$293,293

$358,646

$394,629

$655,943

$798,618

$593,201 $571,293

$646,282 $629,576

$643,607

$626,723 $635,728

$638,229

$15,394 $14,812 $28,453

($850)

($16,219)($3,272)

$18,024 $1,840 $229 $7,138 $18,479

$103,398

$59,430 $33,183

$9,512 $49,714

$59,175

($40,946)

($118,448)

($11,846)($7,854)($5,084)($7,057)($4,412)($5,694)

($200,000)

($100,000)

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q12012

Q22012

Q32012

Q42012

Ass

ets (

$MM

)

Estimated Assets Net Asset Flow

SOURCE: HFR Q4 2012 REPORT

10

80 127 168 237 291 377 389 426 477 515 538 550

781

1,232

1,654

1,9962,221

2,462 2,439

2,1622,037 2,001 1,870

530694

937

1,277

1,654

2,006

2,3922,564

2,848

3,102

3,335

3,904

4,598

5,065

5,782

6,665

7,241

7,634

6,845 6,883

7,200

7,574

7,940

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

# Fun

ds

Fund of Funds Hedge Funds

GLOBAL # OF FUNDS: HEDGE FUNDS VS. FUND OF FUNDS

SOURCE: HFR Q4 2012 REPORT

11

507

261

450 348 328

673

1,087 1,094

1,435

2,073

1,518

1,197

659 784

935

1,113

304 245 275

(109) (52)(115) (57) (71) (92)

(162) (176)(296)

(848)(717)

(563)

(1,471)

(1,023)

(743) (775)

(232) (192) (211)

(2,000)

(1,500)

(1,000)

(500)

0

500

1,000

1,500

2,000

2,500

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q12012

Q22012

Q32012

Numb

er of

Fund

s

Launches Liquidations

GLOBAL HF LAUNCHES/LIQUIDATIONS

SOURCE: HFR Q4 2012 REPORT

12

57.33%

7.83%

7.16%

7.03%

5.72%

6.2%

3.24% 5.48%

< $10 million$10 to $25 million$25 to $50 million$50 to $100 million$100 to $200 million$200 to $500 million$500 to $1 billion>$1 billion

0.15% 0.45% 0.92%

1.76%

2.84%

6.86%

7.95%

79.07%

By # of funds By fund AUM size

GLOBAL HF COMMUNITY – 4Q 2012

SOURCE: HFR Q4 2012 REPORT

13

Europe 10.85%

Asia 14.35%

Americas 43.38%

Other 26.42%

Europe 7.19%

Asia 3.92%

Americas 39.76%

Other 49.14%

Geographic location of funds

Geographic location of assets (AUM)

GLOBAL HF COMMUNITY – 4Q 2012

Source: HFR Q4 2012 Report

ASIA PACIFIC HEDGE FUNDS – 3Q 2012

14

CTA/Commodities 1%

Currency 1% Distressed

2%

Event Driven/Special Situations 3%

Fixed Income

7%

Long only 12%

Long Short Equities 51%

Macro 4%

Managed Futures 2%

Market Neutral 2%

Multi-Strategy 11%

Others 2%

Real Estate 0%

Relative Value 2% Strategy Mix

Fixed income 5%

Long short equities 72%

Macro 11%

Market neutral 6%

Multi Strategy 6%

New Launches Event

Driven/Special Situations

4% Fixed

Income 4% Long only

4%

Long Short Equities 59%

Macro 8%

Multi-Strategy 13%

Others 4%

Relative Value

4%

Closures

SOURCE: GFIA

HFRI HEDGE FUND – WEIGHTED COMPOSITE INDEX (QUARTERLY PERFORMANCE 1998 – 4Q 2012)

15

5.61

(1.27)

(8.80)

7.90

4.06

9.07

0.67

14.91

7.83

(1.25)

1.91

(3.26)

(0.50)

3.46

(4.03)

5.90

1.65

(1.62)

(3.85)

2.51

0.82

7.74

4.36

5.47

3.71

(1.04)

0.79

5.41

0.75 1.12

5.12

2.06

5.98

0.04

1.01

5.41

2.76

4.56

1.20 1.12

(3.44)

2.16

(9.60)(9.19)

0.33

9.20

6.73

2.61 2.38

(2.67)

5.02 5.35

1.70

(0.92)

(6.77)

0.85

4.71

(2.83)

3.02

1.33

(15)

(10)

(5)

0

5

10

15

20Q

1-19

98Q

2-19

98Q

3-19

98Q

4-19

98Q

1-19

99Q

2-19

99Q

3-19

99Q

4-19

99Q

1-20

00Q

2-20

00Q

3-20

00Q

4-20

00Q

1-20

01Q

2-20

01Q

3-20

01Q

4-20

01Q

1-20

02Q

2-20

02Q

3-20

02Q

4-20

02Q

1-20

03Q

2-20

03Q

3-20

03Q

4-20

03Q

1-20

04Q

2-20

04Q

3-20

04Q

4-20

04Q

1-20

05Q

2-20

05Q

3-20

05Q

4-20

05Q

1-20

06Q

2-20

06Q

3-20

06Q

4-20

06Q

1-20

07Q

2-20

07Q

3 20

07Q

4 20

07Q

1-20

08Q

2-20

08Q

3-20

08Q

4-20

08Q

1-20

09Q

2-20

09Q

3-20

09Q

4-20

09Q

1-20

10Q

2-20

10Q

3-20

10Q

4-20

10Q

1-20

11Q

2-20

11Q

3-20

11Q

4-20

11Q

1-20

12Q

2-20

12Q

3-20

12Q

4-20

12

Ret

urn

%

SOURCE: HFR Q4 2012 REPORT

HFRI FUND OF HEDGE FUND INDEX (QUARTERLY PERFORMANCE 1998-Q4 2012)

16

4.97

(0.58)

(10.02)

1.04

3.29

7.08

0.72

13.52

7.08

(2.21)

0.60

(1.19)

0.73

1.54

(1.83)

2.38

0.98

0.20

(1.45)

1.32 1.15

4.01

2.25

3.74 3.16

(1.51)

0.29

4.86

0.80 0.16

4.18

2.20

5.00

(0.78)

0.53

5.40

3.16

4.53

0.27

1.97

(4.24)

1.90

(10.41)(10.05)

0.37

4.81 4.43

1.47 1.41

(2.59)

3.27 3.62

0.88

(1.18)

(4.98)

(0.47)

3.37

(2.31)

2.42

1.34

(15)

(10)

(5)

0

5

10

15Q

1-19

98Q

2-19

98Q

3-19

98Q

4-19

98Q

1-19

99Q

2-19

99Q

3-19

99Q

4-19

99Q

1-20

00Q

2-20

00Q

3-20

00Q

4-20

00Q

1-20

01Q

2-20

01Q

3-20

01Q

4-20

01Q

1-20

02Q

2-20

02Q

3-20

02Q

4-20

02Q

1-20

03Q

2-20

03Q

3-20

03Q

4-20

03Q

1-20

04Q

2-20

04Q

3-20

04Q

4-20

04Q

1-20

05Q

2-20

05Q

3-20

05Q

4-20

05Q

1-20

06Q

2-20

06Q

3-20

06Q

4-20

06Q

1-20

07Q

2-20

07Q

3 20

07Q

4 20

07Q

1-20

08Q

2-20

08Q

3-20

08Q

4-20

08Q

1-20

09Q

2-20

09Q

3-20

09Q

4-20

09Q

1-20

10Q

2-20

10Q

3-20

10Q

4-20

10Q

1-20

11Q

2-20

11Q

3-20

11Q

4-20

11Q

1-20

12Q

2-20

12Q

3-20

12Q

4-20

12

Ret

urn

%

SOURCE: HFR Q4 2012 REPORT

ASIA PACIFIC HEDGE FUNDS PERFORMANCE

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SOURCE: GFIA

COMMON MISCONCEPTIONS

• Deep local investor base • Easy foreign funding sources • High returns • Low-cost operations • No strategy

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ISSUES FACING ASIA’S HEDGE FUND INDUSTRY • Scalability • Profitability • Long-only Small Cap

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CONSEQUENCES OF INSTITUTIONALIZATION • Smaller number of larger tickets • More single global portfolios, less regional and thematic portfolios • Pension have very little appetite for high beta in their hedge fund portfolios • Higher expectations for transparency and governance • Higher expectations for infrastructure • Fee pressure for larger tickets and longer lockups • “Small” is $1-3 billion, which traditionally large for Asian managers

“Higher barrier to entry”

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ASIA IN A GLOBAL PORTFOLIO • Is Asian long short a differentiated alpha source?

- With a few managers yes, but industry wide unproven - China – good; India – poor - Very correlated with global liquidity flows - Japan scores surprising well here

• Does Asia have more mispriced opportunities? - Yes, BUT oThe ability to hedge is more limited oThe stress in a liquidity shock is higher

• What does Asia offer that is unique?

- Credit cycle – great opportunities in the illiquid space - Currencies and interest rates – differentiated macro opportunities

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ASIAN MANAGER FUND FLOWS • The big get bigger and smaller managers are overlooked. The industry

has barely grown but the large managers are getting an increasing share.

• Lack of interest in high net (>50%) hedge fund managers. The market now prefers either a lower net (<50%) hedge fund or a boutique long-only manager.

• Smaller managers struggle to get institutional money and are subject to very fickle flows from financial intermediaries and smaller family offices.

• Even a large Asian manager can reach capacity very quickly as in a global context their capacity is a relatively small number.

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HOW HAVE DUE DILIGENCE REQUIREMENTS CHANGED SINCE 2008?

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• Increased scrutiny • Increased fiduciary responsibility • Increased time and resource requirements • Increased regulatory burden • Increased potential liability • Increased accountability • Increased cost

LEADING TO…

DUE DILIGENCE REQUIREMENTS WHEN INVESTING IN HEDGE FUNDS

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OPERATIONAL DUE DILIGENCE • Compliance manual (including KYC checks,

money laundering procedures, trade errors, soft commission policies etc.)

• Prime brokerage agreement • Fund administrator agreement • Investment management agreement • Business continuity documentation • Projected budget for the next 5 years • Trading and portfolio management system

verification • Authorization, execution, confirmation,

settlement, reconciliation and accounting policies. (need for adequate segregation of duties)

• Detailed valuation policies or a pricing matrix (maintaining transparency, consistency and oversight)

• Counterparty risk • Key person risk and insurance

RISK WITHOUT RETURN

INVESTMENT AND RISK DUE DILIGENCE

• DDQ • Prospectus • Fund presentation • Risk limits • Kroll reports and character references • Analysis of market and product liquidity, volatility

and credit risks • Modelling performance can be difficult: downside deviation, correlation, variance, volatility, VAR, Sortino and Sharpe ratios • Back testing • Scenario analysis • Consistent approach to portfolio management • Definition and measurement of risk to the portfolio • Investment in non-listed instruments • Best execution • Conflicts of interest • Stock borrowing • Personal account dealing • Investment decision-making process

RISK WITH RETURN

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2008 2009 2010 2011 2012

>1 Year

7-12 Months

3-6 Months

>3 Months

Longer

Shorter

Stayed the Same

“Two thirds of investors take between 3 and 6 months to complete due diligence on a manager whereas only a third did so in 2002.” Need to regularly redo DD

DUE DILIGENCE On average, how long is your due diligence process?

How has this changed in the last 12-24 months?

SOURCE: 2012 DEUTSCHE BANK ALTERNATIVE INVESTMENT SURVEY

WHAT’S NEXT • Launches will be bigger and will have a “fully-loaded” infrastructure as comparisons

to a higher global standard will continue. • Appointment of independent valuation agents for hard-to-value instruments will

continue. • Fees will maintain levels of a 1.5-2% management and 20% performance fee,

except for: - Long-bias funds where beta delivery will not enjoy such riches (unless stellar

alpha!) - Strategies requiring longer-term capital commitments • Allocations to Asian funds likely – many investors continue to be underweight in the

industry and the region. • The fund of hedge funds industry needs to continue its recovery and differentiation. • New capital will continue to remain tight and long lead times will continue. • Asia-based investors will increase in importance – pension and sovereign wealth

funds continue to emerge, cash rich and have undeployed capital to allocate

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CHALLENGES AHEAD

• Darwinian culling of the industry continues • Still a poorly capitalized industry • Selling the dream • Flows coming from institutions • Rise of private investment clubs, institutional platforms • Collision of two worlds • Short selling in retail products will come • Hedge funds to become alternatives again

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CAREERS

• Different types of jobs in the hedge fund industry

• Skill sets required

• Where are the opportunities?

• How can candidates prepare themselves for a job in the hedge fund industry?

• CAIA vs. CFA

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