A venture for Asia exposure
A joint venture between Marshall Wace and GaveKal brings together top-flight long/short capabilities with seasoned Asia research. Martin Steward finds that 2008 gave it a baptism of fire
Plenty of column inches get devoted to the economic consequences of global rebalancing. Not so many tackle what it means for the investment management industry. But that is certainly one way Louis-Vincent Gave, CEO of MW GaveKal, interprets "one of the biggest quandaries in the world we live in".
"Asians save everything they earn and Americans save nothing - and yet the US has the biggest savings industry and Asia has virtually none," he observes. "There is a great opportunity for a world-class franchise dedicated to Asian investment that raises money from Asia."
MW GaveKal is a joint venture formed in 2008 between the asset management business of GaveKal Partners and hedge fund giant Marshall Wace. Paul Marshall and Ian Wace had become regular dinner guests of GaveKal's in its home town of Hong Kong, because they, too, had recognised the potential of the Asian investor, launching an Asian version of their ‘TOPS' (trade optimized portfolio system) long/short strategy in 2006 and opening a Hong Kong office to promote it.
"But doing this from London is not so easy," says Gave. "After a couple of years Paul said to me: ‘You've got a great team, great local knowledge and information flow, you're in the region - why don't we team up?'"
Marshall Wace had known GaveKal since its beginnings as a global economic research provider. Both were established in 1998, and Marshall Wace was GaveKal's second client. GaveKal was set up by journalist and economist Anatole Kaletsky, Paribas alumnus Louis-Vincent Gave and his father, Charles, co-founder and CIO at Cursitor Asset Management until he sold it to Alliance Capital (which was GaveKal's first client). Within a few years they had decided that Asia was where the action would be and the younger Gave moved out to establish the Hong Kong office. Beijing followed soon after.Today, 29 of the firm's 42 employees work from Asia, and early clients like Alliance Capital, Marshall Wace, GIC and ADIA have been joined by more than 500 others across the world.
"GaveKal Research offers global analysis with a very strong Asia slant," says Gave. "Between half and two-thirds of what we write about concerns Asia, and half of that at least is about China. As we were developing all this we thought it would be a shame to be at the start of a bull market and not be able to participate, so we started a money management firm. We also felt that it would help balance the highly-cyclical research business."
All of GaveKal's investment strategies - an Asia balanced and Asia and Greater China equity funds - were top-down and long-only. Clients want Asia exposure, Gave reasons, which is offered with tactical allocation into bonds or cash for downside protection (the balanced fund can put 80% in bonds and cash, the equity funds up to 70% in cash). "The cycles in Asia can be huge," he says. "It doesn't make any sense to ride them downwards, and it can be as efficient to protect the downside that way than by shorting."
Since inception in 2003, a benchmark 50/50 portfolio has returned 9.5% annualised, the MSCI Asia index has returned around 11.5% and the GaveKal balanced strategy has returned 12.2% - outperforming equities with lower volatility. Moreover, Gave argues that, right now, this portfolio approach makes more sense in Asia than in developed markets. He remains bullish on equities - "if you've survived 2008 it's because you've cut your costs and dumped your vanity projects, cost of capital has never been so reasonable, and valuations are still not that stretched" - but the bonds are also more likely to provide diversification in Asia than in Europe or the US.
"Pension funds have 50% of their portfolios in sovereign bonds because they think it hedges the 50% they have in equities," he says. "But the main risk to equities today is a bond market meltdown, just like 1994, so that ‘hedge' is anything but. Except of course, when it comes to Asia, where bonds are still undervalued, under-owned, and typically yielding higher than bonds issued by Western governments with much less healthy balance sheets."
Not that they are boring. A little spice can be added with positions like Vietnam, Malaysia, the Philippines, Thailand. And for Gave, Indonesia is "the next great trade, almost a mini-Brazil", as it benefits from both the commodities and domestic consumption booms, a forthcoming Russia-style flat tax rate, and the resulting regular upgrades from ratings agencies.
With the joint venture, GaveKal's research arm spun out independently and its long-only funds were augmented with Marshall Wace's fundamental long/short Asia and Japan strategies.
The Asian TOPS strategies, which remain outside the joint venture, enjoyed an exceptional year in 2009, particularly Japan TOPS: while the Topix index struggled towards a 6% return, it returned over 28%, while maintaining average net exposure of 30-40%. "If it was in any other market everyone would be clamouring for it," says Gave, wryly.
Japan is also the focus for the first fundamental long/short strategy seeded by MW GaveKal itself, the first of a planned family. Managed by Rod Rehnborg and Tomonori Kaneko, it takes the most egregiously inefficient sectors - such as retail, machinery, financial services and construction - and pair-trades the handful of companies they expect to emerge as winners from each sector against those facing imminent demise. This formula seems tailor-made for Japan, and the fund's return since inception of about 15% from 4% volatility puts it among the best Sharpe ratios of the Marshall Wace family. "Japan has been a superb market for our hedge funds, maybe because there are so few genuine hedge funds still operating there," Gave observes.
Indeed, and there are probably even fewer now. Neither Marshall Wace nor GaveKal emerged unscathed from 2008. The former saw its assets under management tumble from $13bn to $4bn (despite mostly solid performance, and largely due to client withdrawals - the firm did not put up any gates); the latter from about $500m to $200m (it is now back to about $400m).
"The survivors will be those who've managed to keep AUMs above $200m, who never gated their investors, and are back above their high watermarks," says Gave. "It's been a tough 15 months, a real baptism of fire. I've been constantly on the road talking to clients, persuading them that it's not the time to sell Asia - but a lot were selling because they had to, of course."
Staying in the game will pay off, he argues. Asian markets have changed fundamentally. Whereas bear markets used to hit when everyone - foreigners and locals alike - sold out, in 2008 Gave notes that local investors generally looked through the technicals to the fundamental stories that are part of their everyday lives.
"The foreigners haven't come back yet," says Gave, who reckons that if local central banks maintain current levels of liquidity, foreign capital flows could result in "a melt-up" similar to the late-stage tech bubble. "Just as the tech investors weren't going to sell on some slight, short-term strength, so we see the same thing with China and Asia today. So if the foreigners come back in, there will be no marginal sellers." He doubts central banks will get too hawkish for fear of sending currencies through the roof. But if they do, that currency appreciation will come through in bonds, again making the argument for MW GaveKal's balanced strategy.
Which leaves one final question: Why Asia and not global emerging markets? One big call that Gave admits getting wrong is his expectation, in the early 2000s, that Asia would enjoy a "triple-merit scenario" of rising exchange rates, falling real interest rates and rising asset prices. Of course, Asia did very nicely - but the triple-merit scenario went to the commodity producers: Canada, Australia, Brazil, Russia, Norway, South Africa. One of the beauties of the BRICs concept is its yin-yang balance of two commodity producers with two consumers.
"I wish I'd come up with the BRICs concept," Gave laughs. "But we've built these strategies and sold them on the basis that you need exposure to Asia because that's where the growth is coming from. China is 12% of GDP now, and it's not even part of MSCI Asia. That's going to change; you need to get in front of it, and I'd be lukewarm about playing that through commodities."