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<TABLE border=0 cellSpacing=0 cellPadding=0 width=452><TBODY><TR><TD vAlign=top width=452 colSpan=2>Published March 31, 2010
</TD></TR><TR><TD vAlign=top width=452 colSpan=2>Temasek's Seatown: a fund within a fund
Reasons, challenges and benefits for the existence of a multi-strategy hedge fund
By BERNARD LEE
TEMASEK announced its recent plan to form an investment company known as Seatown, which is expected to be a multi-strategy hedge fund.
<TABLE class=picBoxL cellSpacing=2 width=100 align=left><TBODY><TR><TD>
</TD></TR><TR class=caption><TD>Through the looking glass: At the end of the day, any internal hedge fund representing only a few per cent of the total assets under management by an SWF may not make a big difference to overall investment performance. However, if something does go wrong, such an entity can face intense public scrutiny </TD></TR></TBODY></TABLE>At the end of the day, any internal hedge fund representing only a few per cent of the total assets under management by a sovereign wealth fund (SWF) may not make a big difference to overall investment performance.
=> Why bother with it then? Cos Ho Jinx is so used to using good money to chase after bad with NO REGRET!
However, if something does go wrong, such an entity can face intense public scrutiny. Given such asymmetrical benefits to Temasek, there must be some solid reasons to justify Seatown's existence.
Size Matters
The practical constraint faced by any entity such as Seatown is the typical size of a SWF, which is usually in the hundreds of billions of dollars.
Hedge funds produce returns by out-performing market indices. In general, the total amount of out-performance (also known as 'alpha') available in the global markets is thought to be limited. When the participation of hedge funds in global markets is relatively small, there is plenty of alpha to go around. Once hedge funds are significant participants of global market activities, alpha will become increasingly scarce. This is supported by academic evidence.
<TABLE border=0 cellSpacing=0 cellPadding=5 align=left><TBODY><TR><TD bgColor=#ffffff>[FONT=Geneva, Helvetica, Verdana, Arial, sans-serif]<!-- REPLACE EVERYTHING IN CAPITALS WITH YOUR OWN VALUES --><TABLE class=quoteBox border=0 cellSpacing=0 cellPadding=0 width=144 align=left><TBODY><TR><TD vAlign=bottom>
</TD></TR><TR><TD bgColor=#fffff1><TABLE border=0 cellSpacing=0 cellPadding=0 width=124 align=center><TBODY><TR><TD vAlign=top>Once hedge funds are significant participants of global market activities, alpha will become increasingly scarce.
</TD></TR><TR><TD vAlign=top>
</TD></TR></TBODY></TABLE></TD></TR></TBODY></TABLE>When investors of the size of typical SWFs begin allocating to hedge funds, investing in hedge funds may become a self-defeating proposition. An alternative proposal is as follows: Can an entity such as Seatown act as a 'hedge' to protect Temasek's main portfolio?
The idea sounds appealing. However, hedging does not work well, if the hedge can only be created by short-selling essentially the same assets as those already held in one's portfolio - especially when the amount that needs to be sold is sufficiently large to crash the market. Option theories work primarily based on the assumption of infinite liquidity. Size is a serious potential problem.
As a simple example, a 10 per cent out-of-the-money one-year put option on the S&P500 will cost about $3 billion in option premium (priced on Feb 16) just to cover $50 billion in equity exposure, which is still a fraction of the current equity holdings of Temasek. If the S&P500 falls by less than 10 per cent on the expiration date of the option, such an option will expire worthless, losing the full amount of capital that Seatown is expected to manage.
A potentially more appealing idea is tactical asset allocation. Since Temasek is known to hold long-term investments, it cannot easily sell down some of those holdings when the exposure is too volatile. In that case, Seatown can execute an equity swap, to temporarily get out of an undesirable market exposure, in exchange for a more desirable market exposure.
Doing so does make sense in theory, but there are other practical challenges. Large orders will be visible in the market no matter how well disguised they are. Shorting the currency of a neighbouring country in distress may be a right investment move but it could create a possible diplomatic nightmare.
Absolute Return
The investment objective of an entity such as Seatown is thought to be that of achieving 'absolute return'.
Market indices (also known as 'beta') are cheap and reliable, but they are also volatile. Since most of Temasek's investments are equity-based, looking for non-equity indices to create 'absolute returns' may be easier said than done, especially in large volume.
One may look for counter-cyclical indices that are 'uncorrelated' with the equity investment cycle. For instance, while it is commonly thought that commodity is an uncorrelated asset, the recent financial crisis has shown that this is not necessarily the case. Demands of commodities do respond to declines in underlying economic activities and ultimately production. Later in the series, we will explore whether commodity prices should be considered a leading indicator of economic growth/decline, instead of any uncorrelated or countercyclical index.
Another common strategy is to look for one-off opportunities to invest in distressed assets, such as certain private equity holdings being put up for sale by university endowment funds at steep discounts. The idea is to capture significant gains in exchange for providing short or medium-term liquidity. But such opportunities come and go, now that the 'easy' money has already been made during the financial crisis.
Instrument of the State
Temasek is a vehicle holding strategic long-term investments for the state of Singapore. Long-term investors such as SWFs and private equity firms typically anticipate holding periods of at least five years or longer.
=> So how have Sporns benefitted so far from the Familee's RECKLESS PUNTING?
Most long-term investors are keen to hold onto their investments to capture the initial period of excitement. An entity such as Seatown can then be used to 'repackage' successful investments already in their harvesting periods for non-professional investors. Commercially, early-stage investments may be much more difficult to explain to non-professional investors than the later-stage ones, thereby creating an opportunity for early investors to recycle their capital.
=> Sell junk to CPeeF account holders again?
There is another benefit of non-professional participation. The 16 per cent year-on-year compounded return of Temasek since inception, as reported last August, is fairly exciting.
=> Fcuking bullshit again. So why are Sporns only paid 2.x% on their CPeeF and told to work till they DIE?
When the public is allowed to participate in similar investments, they can better appreciate the nature of such investments (as compared with the rest of their portfolios), and may adopt more rational and pragmatic attitudes towards short-term mark-to-market losses.
A final potential benefit is that Seatown can provide a neutral platform to get other SWFs to participate in specific investment deals. The deputy governor of the People's Bank of China made the recent suggestion of a possible supranational SWF. Foreign governments and their citizens may be less likely to (mis)perceive any hedge-fund-like, semi-autonomous entity with multiple SWF investors to be a blunt instrument of the state.
Visiting Associate Professor of Economics (Practice) Bernard Lee is the deputy director of the Sim Kee Boon Institute of Financial Economics at the Singapore Management University. This is the first of SMU's four-part series on Markets.
[/FONT]</TD></TR></TBODY></TABLE>
</TD></TR><TR><TD vAlign=top width=452 colSpan=2>Temasek's Seatown: a fund within a fund
Reasons, challenges and benefits for the existence of a multi-strategy hedge fund
By BERNARD LEE
TEMASEK announced its recent plan to form an investment company known as Seatown, which is expected to be a multi-strategy hedge fund.
<TABLE class=picBoxL cellSpacing=2 width=100 align=left><TBODY><TR><TD>
</TD></TR><TR class=caption><TD>Through the looking glass: At the end of the day, any internal hedge fund representing only a few per cent of the total assets under management by an SWF may not make a big difference to overall investment performance. However, if something does go wrong, such an entity can face intense public scrutiny </TD></TR></TBODY></TABLE>At the end of the day, any internal hedge fund representing only a few per cent of the total assets under management by a sovereign wealth fund (SWF) may not make a big difference to overall investment performance. => Why bother with it then? Cos Ho Jinx is so used to using good money to chase after bad with NO REGRET!
However, if something does go wrong, such an entity can face intense public scrutiny. Given such asymmetrical benefits to Temasek, there must be some solid reasons to justify Seatown's existence.
Size Matters
The practical constraint faced by any entity such as Seatown is the typical size of a SWF, which is usually in the hundreds of billions of dollars.
Hedge funds produce returns by out-performing market indices. In general, the total amount of out-performance (also known as 'alpha') available in the global markets is thought to be limited. When the participation of hedge funds in global markets is relatively small, there is plenty of alpha to go around. Once hedge funds are significant participants of global market activities, alpha will become increasingly scarce. This is supported by academic evidence.
<TABLE border=0 cellSpacing=0 cellPadding=5 align=left><TBODY><TR><TD bgColor=#ffffff>[FONT=Geneva, Helvetica, Verdana, Arial, sans-serif]<!-- REPLACE EVERYTHING IN CAPITALS WITH YOUR OWN VALUES --><TABLE class=quoteBox border=0 cellSpacing=0 cellPadding=0 width=144 align=left><TBODY><TR><TD vAlign=bottom>
</TD></TR><TR><TD vAlign=top>
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</TD></TR></TBODY></TABLE></TD></TR><TR><TD height=39>
The idea sounds appealing. However, hedging does not work well, if the hedge can only be created by short-selling essentially the same assets as those already held in one's portfolio - especially when the amount that needs to be sold is sufficiently large to crash the market. Option theories work primarily based on the assumption of infinite liquidity. Size is a serious potential problem.
As a simple example, a 10 per cent out-of-the-money one-year put option on the S&P500 will cost about $3 billion in option premium (priced on Feb 16) just to cover $50 billion in equity exposure, which is still a fraction of the current equity holdings of Temasek. If the S&P500 falls by less than 10 per cent on the expiration date of the option, such an option will expire worthless, losing the full amount of capital that Seatown is expected to manage.
A potentially more appealing idea is tactical asset allocation. Since Temasek is known to hold long-term investments, it cannot easily sell down some of those holdings when the exposure is too volatile. In that case, Seatown can execute an equity swap, to temporarily get out of an undesirable market exposure, in exchange for a more desirable market exposure.
Doing so does make sense in theory, but there are other practical challenges. Large orders will be visible in the market no matter how well disguised they are. Shorting the currency of a neighbouring country in distress may be a right investment move but it could create a possible diplomatic nightmare.
Absolute Return
The investment objective of an entity such as Seatown is thought to be that of achieving 'absolute return'.
Market indices (also known as 'beta') are cheap and reliable, but they are also volatile. Since most of Temasek's investments are equity-based, looking for non-equity indices to create 'absolute returns' may be easier said than done, especially in large volume.
One may look for counter-cyclical indices that are 'uncorrelated' with the equity investment cycle. For instance, while it is commonly thought that commodity is an uncorrelated asset, the recent financial crisis has shown that this is not necessarily the case. Demands of commodities do respond to declines in underlying economic activities and ultimately production. Later in the series, we will explore whether commodity prices should be considered a leading indicator of economic growth/decline, instead of any uncorrelated or countercyclical index.
Another common strategy is to look for one-off opportunities to invest in distressed assets, such as certain private equity holdings being put up for sale by university endowment funds at steep discounts. The idea is to capture significant gains in exchange for providing short or medium-term liquidity. But such opportunities come and go, now that the 'easy' money has already been made during the financial crisis.
Instrument of the State
Temasek is a vehicle holding strategic long-term investments for the state of Singapore. Long-term investors such as SWFs and private equity firms typically anticipate holding periods of at least five years or longer.
=> So how have Sporns benefitted so far from the Familee's RECKLESS PUNTING?
Most long-term investors are keen to hold onto their investments to capture the initial period of excitement. An entity such as Seatown can then be used to 'repackage' successful investments already in their harvesting periods for non-professional investors. Commercially, early-stage investments may be much more difficult to explain to non-professional investors than the later-stage ones, thereby creating an opportunity for early investors to recycle their capital.
=> Sell junk to CPeeF account holders again?
There is another benefit of non-professional participation. The 16 per cent year-on-year compounded return of Temasek since inception, as reported last August, is fairly exciting.
=> Fcuking bullshit again. So why are Sporns only paid 2.x% on their CPeeF and told to work till they DIE?
When the public is allowed to participate in similar investments, they can better appreciate the nature of such investments (as compared with the rest of their portfolios), and may adopt more rational and pragmatic attitudes towards short-term mark-to-market losses.
A final potential benefit is that Seatown can provide a neutral platform to get other SWFs to participate in specific investment deals. The deputy governor of the People's Bank of China made the recent suggestion of a possible supranational SWF. Foreign governments and their citizens may be less likely to (mis)perceive any hedge-fund-like, semi-autonomous entity with multiple SWF investors to be a blunt instrument of the state.
Visiting Associate Professor of Economics (Practice) Bernard Lee is the deputy director of the Sim Kee Boon Institute of Financial Economics at the Singapore Management University. This is the first of SMU's four-part series on Markets.
[/FONT]</TD></TR></TBODY></TABLE>
