A P: Here come the hedgies

Three promising hedge funds feel that access to Indian companies is better from outside than in India.

In the last couple of months, at least three prominent fund managers, well-known and respected in India, have announced their intention to quit their organisations and set up hedge funds of their own. This is the beginning of a trend in India which is already well-established overseas. The best talent in the large fund management complexes, slowly but surely, is trickling out and going out on its own. There are two broad reasons for this exodus: first, the economics of a successful hedge fund is just way too compelling. There is no way that the established fund management complexes with their huge size but only 1 per cent fees can compete with the 2 and 20 crowd (typical hedge fund fees are 2 per cent management fees and 20 per cent of profit). Payouts in the many millions of dollars are not uncommon for successful hedge fund managers.

The second common reason is that most of the established fund management complexes, as they grow larger and larger, get run more as a business than as an investment shop. They tend to act and think more and more as index plus investors and no longer as pure stock pickers. The lead fund managers also are forced to spend more time marketing and less time picking stocks. The fund managers also very often lose control over their funds in terms of being able to dictate when to stop accepting money, capping size, etc. Fund managers who wish to go back to the good old days of just focusing on stock picking, and not having to worry about benchmarks or peer group performance, also find the hedge fund model of absolute performance very tempting. Only focus on the stocks in your portfolio, not on the 200 stocks in the benchmark.

Talking to this new crop of hedgies, one got some interesting insights into the process set up and issues related to it. First of all, none of them expected to get Sebi approval as a foreign institutional investor (FII). To me this seems odd as these guys all have excellent track records and spotless reputations. They all lamented the fact that because their funds were start-ups, Sebi would not consider their applications, even though they personally had long enough track records to meet any Sebi criteria. They also seemed unclear about Sebi's attitude towards hedge funds, as some big hedge funds had got an FII licence, but some other equally large funds had been refused. All were expecting to use access products and synthetics to trade in India, even though they much preferred having an FII licence. Given that hedge funds are the direction the fund management industry is moving towards globally, I do not understand Sebi's reluctance to register them as FIIs. One cannot wish away hedge funds; the best talent is joining them and already they manage more than a trillion dollars globally. The client base of the established hedge funds is the best endowments and pensions; these are not fly-by-night operations. In fact, they are now considered to be the smart money.

Is it not better to register them (hedge funds) as FIIs and get whatever details you need from them, rather than have them access your markets through access products and synthetic structures. Because you have this reluctance to recognise or deal with hedge funds, nearly 50 per cent of the total FII money in India is invested through access products. $50 billion of capital in access products! You have this strange phenomenon in India of Sebi refusing to deal with hedge funds, thus forcing them to use access products, while the RBI wants to ban all access products. Does the RBI understand what a total ban on access products will do the stock markets? Just imagine $40-50 billion of capital flowing out of the country! What will this do to the rupee, interest rates, and stock markets? Seeing all these issues from the viewpoint of a hedge fund start-up, it seems crystal clear that Sebi should finalise a set of criteria to register and recognise bona fide hedge funds, and the sooner this is done, the better.

The second interesting observation was the point of how difficult it was to actually operate any fund (raising money from overseas investors) out of India. All the three hedge fund guys I spoke to were planning to operate from either Singapore or Hong Kong even though they were focused largely on India. When quizzed on the location, the tax situation in India came into sharp focus, for, if the funds were seen to be operating out of India, they would attract Indian corporate tax, which would be totally unacceptable to the investor base. Also, the difficulties in trying to invest in the rest of Asia from India were highlighted""the insularity of the Indian markets and the fact that no international companies did investor road shows in India. Also, all the three felt that access to Indian companies was better from outside than in India. The general infrastructure in Mumbai in terms of the quality of service providers (fund administrators, fund accountants, etc.) was also felt to be lacking.

So much for Mumbai becoming a regional financial centre; it seems that Mumbai cannot even hold on to fund managers focused on India. If we are serious about making Mumbai a regional financial centre, then some type of tax incentives to encourage the fund management industry à la Singapore will be necessary. Capital account convertibility and the RBI using the carrot of offering fund management contracts (for our external reserves) only to global firms setting up offices in Mumbai would also help.

All the three were setting up long-term-oriented hedge funds and were quite confident in being able to raise large sums of money, though not as comfortable in being able to invest the same quickly. The old dilemma plaguing the fund management industry continues in the hedge fund world as well, it seems. The best time to raise money is probably the worst to invest.

All the three start-ups will do very well, to my mind, and set new standards. They will give the existing India funds a run for their money. The game is changing in India as everywhere else. Expect more high-profile personalities to make the leap into the world of absolute investing over the coming 12 months. It is where the future lies.