Correlated Markets Make It tough except for Asia - 05/17/02

It may be time to look at the "out of fashion" areas in the hedge fund arena to gain an edge in what may prove to be a uniquely confusing year. 18 months ago no-one wanted to hear about Japan and Asian hedge funds but recent outstanding performance (mainly due to sharp equity market rises) has brought renewed interest in this part of the world. But HAS THE HORSE bolted?

Our view of the financial world from down under is that it's axis has always firmly rotated around the USA. That is to say US markets are the leader in everything. Outside of periods of local unrest or political and/or major economic upheaval particular to Europe, Asia, South America all of the major markets FOLLOW the US lead.

What was apparent during the recent tech meltdown (Apr-early May) and subsequent frightening rally (post Cisco profit report) is that many markets in a range of areas are watching and trading either positively or negatively correlated to the US stock markets. Gold, currencies, copper, grains, foreign stocks and oil all seem to be taking their lead from the USA stock indices. We have to go back to 1994 to see such exact behavior and recall how tough those markets were for many participants. Add to those tricky correlations a rather schizophrenic pattern of trading in US bond and stock markets, ENRONITIS and its newly occurring strains (Worldcomitis and Dynegyitis) plus a horrible choppy oil market and one can see that 2002 is going to be tricky.

Reviewing the other side of the world (Asia) and the situation has been more positive (Korea and Japan have done well of late) and most of the best returning hedge funds (Oct-Mar) that we review (of a total of 600) in absolute terms have come from Asia or are focused on Asian long/short equity. Even with the perception of extreme volatility there are many Asian strategy funds that have performed well with high absolute returns and high Sharpe Ratios during the last 2-3 years. Sydney based Basis Capital (Asian multi-strategy) and a host of other Asian funds have barely registered any losing months and returns in the high teens to high 20s for almost 2 years now, brilliant stuff in these tough times.

We think the trend towards Asia may continue but warn of the need for an extremely nimble trigger finger in the often dangerous and volatile northern Asian markets. Many an investor is still licking his wounds from 1997.

Gary Parsons
HFA, May 2002
Perth, Australia