Aussie funds eye new strategies

Cash-rich Australian mutual funds are exploring a broader range of strategies, and hedge funds are eyeing overseas markets, driving growth in the country's increasingly competitive prime brokerage market.

Australia's mandatory superannuation pension scheme now holds roughly $600 billion and a good chunk of new inflows before a tax exemption cut off date on June 30 is expected to trickle into more aggressive investment vehicles.

"A number of these (superannuation) funds are looking at the alternative investment space, putting money into fund of funds, and also looking at their own long-short strategies," said James Jennings, head of Australian prime services for Deutsche Bank.

These new participants are entering the alternative market while existing hedge funds are expanding their portfolios beyond Australia, creating a range of new opportunities for international prime brokers, which offer hedge funds services like loans, stock lending and trade execution.

The latest buzz in the Australian market surrounds "130/30" funds, a strategy that lets traditional, more conservative managers sell short up to 30 per cent of their portfolio value and take the cash from their short sales to invest in more stocks they think will rise.

"They need a prime broker because of the 30 per cent they're going short, they need the stock borrow," said Jennings.

Fund managers short a stock by borrowing the shares from a broker and selling them in the expectation the stock will go down, hoping to buy the shares back later at a profit.

The next step for the long-short managers who dominate the Australian hedge fund space is a move abroad, as valuations in their home market get stretched and they seek to diversify.

The benchmark S&P/ASX 200 is up 9 per cent this year and trading near record levels after a 19 per cent rise in 2006.

"For those established managers with a track record in Australia, I think they'll start to look at the rest of Asia and see if their strategy fits in," said Colin Taylor, head of Australian prime brokerage for market leader UBS.

"That will be the new direction," he said.

As the local hedge fund market has grown, investment banks have expanded their prime brokerage teams to steal market share from rivals UBS, Goldman Sachs and Morgan Stanley.

Deutsche Bank hired Jennings from rival ABN AMRO in September 2006 and added three other executives at the time, while Citigroup has also ramped up operations down under.

"We've been selling prime brokerage for only the last 14 months in Australia," said John Gregory, Australia prime brokerage head for Citigroup.

"One of the marked differences of the prime brokerage business in Australia is the client demand for pieces of the service rather than the full suite," he said.

"We've spent considerable effort pulling apart the business in this country to provide the services clients value most highly."

Hedge funds now manage $2.4 trillion globally, making them among Wall Street's biggest fee-payers. Goldman and Morgan Stanley are traditionally the top global players, and in Asia Pacific Lehman Brothers and Merrill Lynch are among the banks bulking up in to win more business in the region.

While traditional managers managing superannuation money seem increasingly willing to play in the hedge fund space, there has been a slowdown in start-ups as the big superannuation funds and entrenched hedge funds crowd out smaller players.

"We saw fewer start-ups last year than in previous years, a key to that is the increased barriers to entry since people now need to start day one with a much more sizable amount of money," said UBS' Taylor.

Those funds are overwhelmingly drawn to long-short strategies, which people say makes up 70 to 80 per cent of the total hedge fund market.

"Superannuation money is looking for new investment opportunities," said Gregory, predicting the market will see more 130/30 equity long/short funds and global macro funds rolled out this year to capture some of that capital.

Australia's $1 trillion asset management industry will more than triple in the next 13 years, consultants Trowbridge Deloitte estimate, a potential boon for the hedge fund market, which was only $4 billion at the end of 2001, prime brokers have said.

"We've effectively seen a doubling of our business year on year," Taylor said, adding that while that pace is likely unsustainable, the future looks promising.

"Growth in the last couple of years has really seen the industry doubling its size," he said.