The Hong Kong Jockey Club
The Hong Kong Jockey Club is in the enviable position of being the monopoly provider of betting services on horse racing, football and the lottery in a territory where people just love to gamble. Betting receipts from the Happy Valley and Sha Tin race courses and the hundreds of betting shops in Hong Kong exceeded HK$102 bn last year.
With that amount of cash changing hands, it is no surprise the Jockey Club is the biggest taxpayer in Hong Kong, contributing 11% of total tax receipts. It is also the largest benefactor in Hong Kong, contributing on average HK$1 billion every year to various charity and community projects for the past decade. As part of Hong Kong’s contribution to the Olympics, the Jockey Club is also hosting the equestrian events of the Beijing Olympics and Paralympics.
Leading the team of professionals who manage the HKJC’s cash and investments is Group Treasurer Jacob Tsang. He has overall responsibility for overseeing the management of the Jockey Club’s US$7.5 bn investment portfolio. As one of the few examples of a local institution with a broadly diversified international portfolio, Tsang has brought in experts from the financial sector in key roles and has built an in-house research and data gathering facility that would be the envy of many a medium sized fund management group. Indeed, such is his status in the local investment community, he has been known to highlight the shortcomings of many in the active fund management industry.
Although the Jockey Club investment team sets target returns for the various segments of the portfolio, it has no specific liabilities to match, so is primarily concerned with making the best risk-adjusted returns. As Tsang says, “We are not like CalPERS, or any of the local institutions, many of which are pension funds. We operate slightly differently; our role is supportive to the overall corporate objective.”
The investment portfolio is split into two main parts - the strategic long term portfolio and the shorter term portfolio which is mainly for liquidity management. The goals for these two parts are inflation plus 3-4% for the long term market portfolio and a cash benchmark for the shorter term portfolio,
In addition to the traditional asset classes like global equity and bonds, these portfolios now incorporate a strategic allocation to alternative assets, which encompass hedge funds, private equity and direct real estate.
The Jockey Club began using hedge funds in 2001 after a period of about two years of evaluation. As Tsang records, it had been a challenge to sell the concept to the board of stewards, given the perceived stigma attached to hedge funds and the fact that many of the board members did not come from the finance industry. Their apprehension of the strategy was understandable, says Tsang, but once they understood the nature of the planned investments, they supported the move. The Club’s objective in using hedge funds was explicit - to diversify and dampen the volatility of the portfolio. The due diligence exercise turned out to be a long drawn-out process, which entailed on-site interviews of some 10 fund of funds managers, by the investment team. The mandate for the two incumbent managers was to pursue an absolute return with a cash rate hurdle. Volatility was somewhat curtailed, given the deliberate strategy to eschew the more directional strategies like global macro. According to Tsang, the deployment of hedge fund managers has achieved its stated objectives and the experience has been satisfactory. The two incumbent managers had been able to deliver very attractive Sharpe ratio with low correlation to other asset classes.
As further allocations have been added to the hedge fund portion over the years, it has been suggested that one natural progression would be to move to invest in single strategy managers. But the argument to support such notion is weak, says Tsang: “Whilst we may not necessarily like to pay the extra layer of fees, the resources available in-house are still rather restrictive to allow us to research, select good managers and construct a diversified portfolio.”
Other implementation issues such as monitoring, rebalancing and negotiating capacity are also perceived to be impediments to the single manager idea. Tsang adds, “We have seen our managers adding to their resources since inception of the program, becoming more specialised and building complex quantitative platforms to manage risk. In the past, one team would be responsible for a range of different strategies. Now, each strategy is treated as an asset class in its own right. Given the size of our portfolio, it would be difficult for us to attain the critical mass to justify such an infrastructure, at this juncture. So we envisage retaining the fund of funds approach for another few years.”
The Club’s experience with traditional active managers has not been entirely a happy one. Naturally, it doesn’t please Tsang to be paying active management fees for the delivery of index-like returns. He has observed managers outperforming and underperforming over the investment cycle, depending on their investment style. Finding an active manager with consistent outperformance has been a challenge. In an effort to resolve the performance issue, the Club relaxed its investment guidelines a couple of years ago, to allow managers to deploy a wider range of investment techniques, with a view to boosting excess returns. Portable alpha, 130/30 and use of derivatives were amongst the strategies managers were allowed to deploy. The results have been encouraging, says Tsang, with improvements in performance observed.
But all these strategies faced difficult market conditions in the second half of 2007 and the early part of 2008, as valuations were negatively impacted by the market dislocation stemming from the credit crisis. The Club was not fazed by this “short term aberration”, says Tsang. They continued to move away from the traditional long-only approach and to pursue the concept of separation of beta and alpha.
Late in 2007, the HKJC terminated a traditional bond mandate with BlackRock but retained the manager with a view to converting the mandate into an alpha transport strategy. Under this approach, the Club replicated the beta element by entering into a swap to receive the bond index return against LIBOR. The cash released by this was in turn invested in a multi-strategy hedge fund portfolio run by US group Quellos, which was acquired by BlackRock in the middle of 2007. The initial mandate was for US$240m.
Tsang and his team had been looking at alternatives to traditional bonds for some time, and they are happy with the results of this new approach; “We saw the opportunity that the group (Quellos) was better equipped to run an integrated solution for us. The new strategy is more efficient and the alpha source is more meaningful and assured.”
Despite all these advantages, Tsang warns that such approach would involve a lot of input from both investor and manager and is not for those without in-depth in-house expertise. “The transaction required a combination of investment and investment banking knowledge. Shopping for the cheapest swap, executing the ISDA, matching the cash flow and monitoring the basis risks were both labour intensive and time consuming. Given there is no off-the-shelf product, a lot of customisation was required,” cautioned Tsang. The Club is hoping that more mandates can be converted in the future, if the current program can demonstrate discernible improvements in the course of the next year or two.
After the inception of the hedge fund program, the Club expanded its exposure to alternative asset class with the inclusion private equity and direct real estate. Carlyle and Goldman Sachs are among the incumbent managers. Although Tsang does not disclose the exact exposure to each asset class, it is believed that the Club’s strategic allocation to alternatives is in excess of 10% and growing. The Jockey Club team does a lot of qualitative risk management in-house, while taking inputs from a variety of external sources. The Club engages consultants to carry out asset allocation studies every year, to ensure that all the assumptions used to run the model are still valid. Policy portfolios are ‘tweaked’ from time to time to ensure that objectives of the portfolio are still achievable. Tsang says, “Going forward, some trends have become obvious - the allocation to alternatives will gradually increase and the long-only portfolios will migrate towards separation of beta and alpha.” Tsang attributed this to the need for diversification and the diminishing appeal of relative investing - but more importantly, a board which is now comprised of individuals “who are more receptive to new ideas”.
The Club has no investments directly in infrastructure and has not adopted a green or SRI approach at this juncture. Tsang says, “Most of these funds are very thematic and opportunistic, be it green, SRI or commodity-based. We still believe taking the broader approach is the more efficient way at aggregate portfolio level. That said, it may change very quickly given the development that is happening in the market. We shall see.”