Q&A with New Hedge Fund Start Up NHF1009
1. When did you start your hedge fund and how many people are involved?
We first established an investment firm in May 2002 with two directors, the CEO and myself with 3,000,000 paid-in capital with an intention to evolve into a hedge fund in the future. The CEO worked for Sanyo, Ark and Dongsuh Securities as well as Saison insurance. I have worked for Merrill Lynch, Barclays, Dongsuh, Citigroup and Nikko Securities. The initial activities included investment consulting, development of new investment/trading tools and proprietary trading. In April 2003, we added a third director, formerly a fund manager at one of the largest investment trust & management companies. He joined us to bring in his expertise at fund management and his programming capability to develop equity long/short strategies. We got lucky with another personal contact, and are now sharing office space with another investment firm in central Tokyo. That really helped to save set up costs.
2. How did you know each other and begin a start up in Tokyo?
The CEO and I first met in 1995 at Dongsuh Securities Tokyo, a Korean securities company’s Tokyo branch office, and worked together until late 1996. Dongsuh went bankrupt in the middle of the Korean economic crisis in 1997. After Dongsuh, the CEO started working as an insurance consultant for Saison Life Insurance and I worked for a small independent asset management company and then for Citigroup as a marketer of alternative investment products including hedge funds. During that time we met from time to time and in February 2002 we first talked about the possibility of starting a new asset management business. Both of us lived in London previously and had seen first hand how well run professional funds could be rune. We wanted to try and replicate that fund management quality in Japan.
3. Where did you get the inspiration for this idea?
The CEO knew through his job as an insurance consultant that there were many unhappy high net worth investors and I also knew through contacts with top financial institutions that institutional investors in Japan, were looking for good hedge funds run by Japanese people that are specialized in Japanese stocks. Having agreed that there would be an increasing demand for hedge funds from both individual and institutional investors, we decided to start a hedge fund venture together to pursue this opportunity. Soon after that, we contacted a friend and consultant, who is a specialist in the development of short term trading systems to ask him to develop a new trading system.
4. What can you tell us about the trading systems that you use now?
There are two systems right now. We also had contacted a fund manager at an investment trust & management company to ask about using his own long/short system. The consultant agreed to develop a new short term trading system and the fund manager also agreed to let us use his own personal system. With these two systems having become available, the CEO and I were confident that this venture would succeed. We were also so confident about the system’s reliability that we borrowed capital for the company from our friends initially, to be managed by these systems and gave our personal guarantee to the borrowings. Using this basic framework, the CEO and I would be responsible for capital rising, risk management and running the young company itself.
5. What kind of trading did you start with? Can you explain any details?
Our firm’s trading activities are primarily based on two equity long/short programs as stated previously. One is a medium to long term long/short strategy, developed by the fund manager, with a 3 to 12 month investment horizon. The other is a newer short term long/short trading strategy, developed by an outside consultant, with a 2 to 3 days horizon. In both strategies, no human judgment is involved in stock selection process. We were inspired by Renaissance Technology Corp, the well known pioneers of this type of hedge fund technical trading. In the long term strategy, stocks are ranked from the most overvalued to the most undervalued by a statistical method based on the Arbitrage Pricing Theory and we create a zero-beta long/short portfolio. In the short term trading strategy, a special program picks stocks that are technically overvalued and undervalued and are likely to go down in price (in the case of overvalued stocks) and go up in price (in the case of undervalued stocks) in the next two to three trading days. These programs were developed by top experts in the industry and we have been witnessing their reliability and stability for over a year. However, at present (October 2003), we only trade the short term strategy. We plan to start trading the long term strategy with our proprietary fund from 2004.
6. What can you tell us about trading results or your returns?
Our short term trading system, picks stocks that are technically overvalued and undervalued, with a high probability of reversing their short term price direction, within two to three trading days. This system was developed by an outside consultant who is an expert in the development of data network-based trading systems. Since the inception of this system in November 2002, we have been trading this system with our proprietary fund. Between November 1, 2002 and May 6, 2003, longs and shorts were not necessarily balanced and as a result we experienced wide fluctuations of daily returns and severe draw downs. Some minor changes were added to the system mainly to reduce the variability of daily returns and we decided to change our trading style to a pure long/short strategy starting from May 7, 2003, in which an equal amount would be allocated to each stock in a long and short portfolio. As a result, the variability of daily returns has been reduced remarkably. The May 7 to Oct 3 returns were 36% for those 5 months, or 86% on an annualized basis.
7. What trading risk views do you have and longer term returns do you expect?
In our short term system, a long/short position is created every day at the opening to be liquidated two days later (on a third trading day) also at the opening. That means if an investor creates a long/short position today at the opening, he or she is supposed to liquidate it at the opening of the day after tomorrow. We believe that the passage of time is one of the biggest risks in investment. One can argue that it is the passage of time that produces high returns, but it is also true that the biggest risk exists right there. This system creates different sets of long/short portfolios every day only to be liquidated two days later. Therefore, we believe the inherent risk of this system is very limited. We believe that an annual return of 50%+ is highly achievable with this system and that is clearly indicated by our actual trading results. Since this is a very short term trading system, it is very important to keep the commissions at an as low level as possible. Otherwise, a large part of trading profits will be eaten by the commissions paid to brokers. We now use an internet broking house with one of the lowest commission levels in the broking industry.
8. What capital amounts are you expecting to raise in future?
For further information about this Hedge Fund and 12 others now listed on the HFJ Capital Mall please contact us at info@hedgefundjapan.com
Follow this link directly http://www.hedgefundjapan.com/en/mall
There seems to be a real turn around in Japanese capital markets as of October 2003. We feel that with the current team, we should focus on a two step approach. Grow towards a US$20-30 million of assets under management and then have a soft close. After a consolidation period, we hope to then grow to US$100 million, before expanding the team substantially. We only have plans for a Tokyo office and are not considering more than 2-3 more staff over the next year.
