Richard Newell assesses the suitability of Hong Kong specialist fund managers for institutional portfolios.

Whatever the future holds for Asian stock and bond markets, there continues to be significant demand for exposure to the region. The flight to private equity is proof that investors still believe in the Asia boom story, as is the growing popularity of hedge fund managers, many of whom have successfully reduced the impact of the Asian meltdown.

But as Nilesh Jasani of SocGen Crosby notes, it is too early to herald stability" in the markets. So the question is how should investors address the region given current volatility?

None of the Asian specialists has come out of the crisis unscathed. Equity fund managers have been talking of increasing their Asian weightings with very careful stock-picking. Rob Brewis, fund manager with Nicholas-Applegate in Hong Kong, comments: "The companies to survive and thrive in this climate are not the same names that have done well in the past, in fact many of those names won't survive, so careful stock selection is more important than ever before."

The 'plain vanilla' fund managers have all had a rough ride as they are tied to prescribed weightings. And they are restricted in their ability to hedge, although some, including Barings are setting up internal hedge fund divisions.

Some have funds that are pitifully small as a result of redemptions. Crosby's Asia Vision fund is down 23% on the year and has only US $1.3m under management. The old BGI Institutional SE Asia fund, now run by Axa Fund Managers, is down 24% on the year and has only $1.2m in the fund.

The best approach would appear to include an element of hedging. George Long, one of the principal directors of Long Investment Management in Hong Kong believes that unless investors are going long and short of the markets, they are missing the real opportunities of investing in Asia at this time: "I think it's too early to think you can buy the market and believe that it's all going to come right. There will be times when you will find that is just too volatile an approach."

Pure hedge funds are probably not the answer. The only two hedge funds to have produced a positive return this year are the Regent Pacific Hedge Fund, (a 17.2% return second quarter but only 0.4% year to date) and Long Investment Management (LIM) Asia Special, which has put on 11.3% since the beginning of the year. The largest of the Asian hedge managers, Sofaer Capital , is down -8.7% year to date.

Long, with $70m under management, specialises in absolute return and quant strategies, convertible bonds and Asian debt. Top Asian debt specialists, Robert Appleby and Chris Botsford have recently teamed up with George Long and Andrew Alexander of LIM, to form Asia Debt Management (ADM) with an initial $115m under management. They have launched a special purpose vehicle, based in Mauritius, the Asia Debt Recovery Company, to hold distressed Asian debt. Robert Appleby maintains: "There is a compelling case for looking at opportunities in value impaired debt in the region. Few will have forgotten the dramatic recovery in Mexican debt in the aftermath of the 1994-5 crash." He believes there are similar opportunities in Asia if one takes a longer view.

Small companies managers have also been poor performers during 1998, although one or two have held their own against the odds. Lloyd George Management's Asian Smaller Companies fund is at least showing a positive return, albeit only 0.8% for the year.

Robert Lloyd George, who left Indosuez to set up his own firm in the early 1990s, suggests that once the present concern over the mainland Chinese currency subsides, a recovery can be expected from Hong Kong's currently oversold level. "However, property values will re-main depressed for some time, and we are emphasising utility stocks and special situations in our portfolios." He adds, "there are sound long term growth situations in Asia selling at very attractive price levels today. Our team is busy searching for these attractive stock picks, which we find in Japan, Hong Kong, Taiwan, Thailand, Philippines, and also India."

ImPac was expected to be one of the success stories of the 1990s. A Hong Kong-based fund management house with an entirely Chinese team of highly-rated fund managers. It has in reality been one of the biggest casualties of the downturn. It was beset by disagreements among senior personnel resulting in several key departures. The recent performance figures show a 29% loss in June alone, and 54% year to date. ImPac is now going through a restructuring, due to the shrinking size of the Asian Pacific Fund (now down to $0.8m). Some sub-funds have been closed and the process is due to be completed at the end of August. The only remaining director from the original team is Gary Ting. Its two main fund managers are Kitty Hon and Kelvin Tang.

Value Partners is a Hong Kong fund management firm specialising in value-investing for Asia. It was found-ed by Cheah Cheng Hye and V-Nee Yeh and now has funds under management of around $174.3m, from 260 institutional and private investors from Asia, Europe and North America.

An investment in the group's 'A' fund, an open-ended unit trust in-vesting primarily in Hong and China, has produced a compound annual return of approximately 17.5% since launch, although this aggregate has de-creased recently.

Cheah Cheng Hye founded the Hong Kong equities research department of Morgan Grenfell in 1989 and his research team was voted second in the Hong Kong medium to small-sized companies category in fund manager surveys in 1991 and 1992. Cheah says: "When we invest, we're more concerned with downside risk than upside reward; the upside will look after itself if you guard against the downside. What this means is that the fund has avoided popular stocks because anything that's too popular becomes overpriced."

The fund ratings company RCP, with offices in Hong Kong and Gen-eva, monitors 230 asset management firms in Asia ex-Japan, including 50 that are rated or about to be rated. The ratings use two scales. These measure the fiduciary risk an investor takes in giving his money to a third party for asset management purposes. Managing director Shane Norman explains that the double rating system "provides fine tuning on the quality of the business organisation ('Business Rating') to focus on the Safety factor, and the quality of the investment organisation ('Investment Rating') to focus on the Performance factor". Organisations rated below Six (Inv-estment Rating) and/ or below A3 (Business Rating) are likely to be ill-suited to serve institutional investors adequately. Norman explains: "This does not necessarily mean they are bad firms, but rather that conflicts of interest, an ill-defined investment process, high staff turn-over and/or a variety of other factors raise the level of fiduciary risk so that use of the firm is considered injudicious for institutional invest-ors."

In the light of recent performance, it is not possible to recommend one single fund manager with any certainty. Norman says RCP "has no particular bias towards big or small, although the system does tend towards the longer cycle value-based, what you might call the traditional Scottish ap-proach."

According to its ratings system, RCP gives largely positive ratings to groups such as Schroders, Indocam, Jardine Fleming, Aberdeen, Lloyd George, Baillie Gifford and Crosby.

All rating verdicts are shown to the managers themselves to avoid factual errors. An indication of the type of analysis provided in individual ratings is given by this example for Regent Pacific: "Regent has few illusions about itself and readily admits to opportunism in its approach to both its investment process and its business development, counting this as a strength. Certainly, strong profits growth and substantial capital re-sources are testament to the firm's business acumen. The product range is innovative, even exciting, and the senior team is cohesive, although individual responsibilities seem elastic and hard to pin down. Performance has been erratic and the investment process is loosely disciplined, but the new CIO may be able to redress both these shortcomings". Unfortunately Chris Jenkins had no sooner joined as CIO than he was heading back to Rothschild from whence he came, leaving Regent looking for a replacement.

At the same time, senior partner Peter Everington has announced he is leaving Hong Kong to work for Regent out of the Isle of Man. RCP's final comment on Regent is that "investors need to be aware that the management looks after its own interests at least as much as those of its clients," which some might see as a positive attribute..."