Brief Introduction of the Equity Strategy - Research Paper Example

Brief Introduction of the Equity Strategy Contents Introduction 1 Equity Investment Strategy 2 Brief introduction of long/short equity strategy 2 The Real Return Asian Fund: Veritas Asset Management 4 The Asia Pacific Equity Income FUND: Blackrock 4 Asia Equity Strategy: UBS 5 Private Equity – The Large Investor Perspective 6 7 Conclusion 8 References 9 9 Introduction This paper discusses current trends adopted by investors in investment strategies in Asia specifically in equities. In our study, we have first studied and analyzed data on what investors feel with regards to Asian investments, the trends, and how that affects equity investment strategy in Asia. Based on that knowledge we analyze the strategy currently prevalent in equity investment in Asia. We provide a description of how the strategy functions. Following the same, we analyze investment strategies and their portfolios in Asian equity. We have used Funds and PE investors for this analysis. Equity Investment Strategy In the recent decade there has been an influx of assets in Asia. As per one report in 2007, inflow of assets flowing into Asia includes 39% in China, 15% in Emerging markets Asia and 7% in Japan. Compared to that asset out flow from US was about 8%. (Deutsche Bank, 2007: p16). Parallel to the creation of a large number of Asian-based hedge funds, a substantial asset inflow in this region is evidence of a growing acceptance of Asia as a domicile (Lhabitant 2006, p. 22). One thing one needs to consider here is the fact that the strategies the hedge funds need to adopt in Asia is different from that in Europe and US, because of the difference in market. As regards equity investment strategy of Funds in Asia, three fundamental factors need to be considered – Asia has the highest degree of investment restrictions in terms of regulatory rules of short-selling or limited stock offerings for short. There are higher inefficiencies and more volatility in the market which can be better exploited in Asia than in US or Europe. The investments in Asia are especially meant as long term investments. In our study of Asian funds we find that most funds have opted for a long/short equity strategy. Typically the investment portfolio of long/short equity strategy consists of a core set of long equity positions which are partially or fully hedged by short sales of borrowed stocks. (Jaeger 2005: p62). However the portfolio may have a net long bias which reduce but do not completely remove market risk. Brief introduction of long/short equity strategy Long/short equity investors follow the school of value investing. (Lhabitant 2006: p170). This includes a bottom-up analysis of long-term intrinsic value of a stock. This is done by financial analysis of a company’s stock price over a period by focusing on the factors that affects them. The analysis includes study of regular financial information such as earnings, cash flows, balance sheet quality, assets and liabilities, and then uses proprietary algorithms for valuation of a stock. Weighted factors influencing the stock are also used in this evaluation, and finally a convergence is reached about the expected real stock price. This process is used for finding undervalued stocks for the long position and overvalued stocks for the short position. Though bottom-up analysis is fundamental, top-down qualitative analysis is also performed. (Jaeger 2005: p63) Top-down approaches aim to identify economic trends and future investment themes in certain industry sectors. Sector specialist hedge funds specialize in specific sectors of the economy such as life science, technology or real estate. In addition to the valuation-based approach sector specialist hedge funds, quantitative approaches and activist strategies as the most popular versions of the long/short equity strategy (Lhabitant 2006, p. 170-176). Quantitative approach uses dedicated software and risk models to select positions, optimize portfolios and evaluate potential trade, which is mostly used in the equity market neutral funds. Activist strategies finally are based on the theory that finding an undervalued situation is not always sufficient to unlock its associated hidden value. Activist managers request or enforce initiatives from company management teams or boards such as the sale of assets that are undervalued on the balance sheet, the assignment of a new management team, giving cash back to shareholders or the assessment of strategic alternatives such as restructuring plans and cost-cutting initiatives. Based on our understanding of the strategy currently used for long term funds in Asia, we will proceed to discuss some Asian funds and their investment portfolio. The Real Return Asian Fund: Veritas Asset Management This fund (Veritas 2010) has received the Tenth European performance award for 2010 and was also short-listed for Best Long/Short Equity Hedge Fund as well as Best Emerging Markets Hedge Fund. The fund was launched in October 2004 and is forecasted to generate 15-20% a year. Using the long/short equity strategy, the investment portfolio of the fund is divided into two separate portfolios. The core portfolio consists of stocks having sustainable and predictable growth and a short-term (up to 6 months) trading portfolio. This is done considering the volatility of the Asian market. While the long term portfolio produces steady income from dividend yield, the trading portfolio capitalizes on market inefficiencies and earnings momentum. According to the Fund Manager the target volatility is 11%, which is approximately half of the market. Thirty-three percent of investors in the fund are funds of hedge funds and another thirty-three percent investors private clients, rest being made up of pension funds etc. Parameter Data Fund Name The Real Return Asian Fund Strategy pan-Asian long/short equities Launch Date October 2004 Portfolio Size $626 Million (04-01-2010) Average Annualized return 17.1% (03-31-2010) Average Annualized Volatility 10.9% (03-31-2010) Sharpe ratio 1:3 Figure 1 – Fund Facts: The Real Return Asian Fund The Asia Pacific Equity Income FUND: Blackrock The fund’s objective is to provide an above average income on equity investments without sacrificing long term capital growth. Similar to Veritas, Blackrock (Blackrock 2011), takes the income style approach by basing their investment strategy on a combination of dividends and earning yields. The distribution of income for this fund (equities in the portfolio vary between80-120) is balloon shaped, that is proportionately higher from its large market capitalized stock and tapers down toward mid-cap and small-cap equities. The stock is beta-flexible with bias towards very cheap stocks in market bottom and high dividend yielding stocks on market peaks. The fund uses a double dividend yield screening process, which takes into account a stock’s monthly yield as well as twelve month forward dividend yield, to screen stocks for top quintile. The second screening helps separate stocks which have high yield but potentially unsustainable from ones which have stable and attractive future dividend yield. These stocks form the Funds portfolio. Asia Equity Strategy: UBS According to UBS (UBS 2009), and also as seen in above examples earnings momentum based strategies are used in the Asian market, and better suited if studied over a three month period. This better suited a directional market rather than turning/inflection points. The study of earnings momentum is similar to Blackrock’s in that it considers earnings momentum for a 12 month forward earnings estimates at a stock level and then aggregating them over region, country at sector level. UBS concludes that earnings momentum works better at the equity level than in region, country or sector level. Private Equity – The Large Investor Perspective Private Equities have significantly invested in Asia, and to understand equity investment strategy we need to understand the PE investors and managers view of the Asian market. This is based on a study conducted by INSEAD and AXA (INSEAD-AXA, 2010) between the period of April to June 2010, from a select group of investors with about $9.4 billion invested in Asia. This constitutes roughly about 10% of their total investment. As regards the managers, they have about $34 billion assets under management (AUM) and have raised about $26 billion between 2002 and 2010, the era of modern Asian PE. The total AUM in Asian PE is about $194 billion. The figure below shows the allocation of Asian PEs in the future, and the data clearly reveals that allocation is purely on side of the increase, with no one deciding to lower their allocation. Figure 2 – Change in Allocation to Asian PE The second important factor to note is what the expectation of return from investment, as is shown below. Figure 3 – Return expectations of PE investors based on geography and distribution of Pan-Asian Funds The next figure shows the strategy and geographies PE investors are concentrating for the next 12-24 month period. Figure 4 – Planned changes in allocation by strategy and growth by PE investors This clearly indicates that focus is more on developing Asia with more exposure to Greater China and India, while allocating less on developed Asia (Japan and Korea) and pan-Asian funds in relative values. Finally, the next figure shows PE investors biggest concerns in developed and developing Asia Figure 5 – PE investors biggest concerns in Asia Conclusion In this paper we have studied and analyzed “equity investment strategy” in Asia. As part of the study we have looked at the strategy used by Funds in Asia. Based on our study, we conclude that – Asian equity investment strategy uses the directional long/short equity strategy. Both bottom-up and top-down analysis is performed on the equities to create the investment portfolio. Asian market is more strictly regulated but opportunities exist due to market inefficiencies. Volatility in Asian market is higher than in Europe and US and hence it is of significant consideration when adopting a strategy. The strategy is driven by dividend yield and earnings momentum. Most investment strategy is focused on long-term gains. Following the same, we have taken the PE investors view of Asian assets. The conclusion from the same is – Investment allocation is growing in Asia from PE perspective. Allocation in future is more on growth funds. Investors are more interested in developing Asia than developed Asia or pan-Asian funds. Some of the risks which need to be considered while formulating Asian equity based funds strategy are – Equity prices may exhibit relatively strong fluctuations based on market conditions Currency risks resulting from a high proportion of foreign investment. Issuer country and credit risks References Blackrock; Asia pacific Equity Income (March 2011). http://www.blackrocklatam.com/content/groups/uksite/documents/literature/1111134708.pdf [Accessed 05-17-2011] Deutsche Bank: Global Markets.( January 2007) 2006 Alternative Investment Survey. Jaeger, Lars (2005): Through the Alpha Smoke Screens: A Guide to Hedge Fund Return Sources, Euromoney Institutional Investor PLC. Lhabitant, François-Serge (2006): Handbook of Hedge Funds, John Wiley & Sons, Ltd, Chichester. The Real Return Asian Fund: Veritas Asset Management(May 2010) : Hedge Funds Review Editorial:,.http://www.hedgefundsreview.com/hedge-funds-review/profile/1636873/the-real-return-asian-fund-veritas-asset-management [Accessed 05-17-2011] INSEAD – AXA (2010): Private Equity survey of top LPs and GPs in Asian Private Equity. www.insead.edu/facultyresearch/...equity.../INSEADAsiaPESurvey.pdf [Accessed 05-17-2011] UBS (November 2009) Investment Research. Asia Equity Strategy. http://www.ubs.com/investmentresearch [Accessed 05-17-2011] INSEAD – AXA Private Equity Survey of Top LPs and GPs in Asian Private Equity Read More