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Hedge funds turn choosy, cut their India exposure

The quality of overseas money being invested in Indian stocks seems to be getting better. Despite the return of foreign institutional investors (FIIs) to the market chasing a zooming Sensex, the bellwether Indian equity index that has gained 77.53% since January, the exposure of hedge funds to local stocks has dipped significantly.

This could mean that the overseas money currently being invested in Indian stocks is here for the longer term.

According to Singapore-based hedge fund tracker Eurekahedge Pte Ltd, hedge fund assets in India were $6-7 billion (Rs28,740-33,530 crore today) at the end of August, sharply down from $18 billion at the end of December 2007, at the height of the bull run. The Sensex hit its lifetime high of 21,206.77 in January 2008.

Hedge funds, which are designed to generate positive returns regardless of the direction of the market’s movement, typically exist outside the scope of regulatory oversight, nor do they report fund size and returns to outsiders.

These funds attempt to maximize return on investment by taking bets on various kinds of global assets—equities, bonds, commodities and currencies— in complex trading strategies that are often backed by even more complex mathematical models.

Hedge funds typically churn their money quickly, often short selling, or selling assets in anticipation of declining prices only to buy them back later, as opposed to pension funds or insurers who invest for a longer tenure.

The fall in these funds’ India assets comes at a time when the global hedge fund industry is recovering from a financial crisis. In August, these funds saw an increase in assets for the fourth consecutive month. They now manage $1.3 trillion; around 300 new funds were launched this year and the rate of closure of existing funds is also slowing.

“No one expected India and China to fall as much as they did,” said Ankur Samtaney, analyst at Eurekahedge. “That’s why in spite of a decent run (so far this year), allocations have been slow because of the big bad ugly drop last year.” The sharp depreciation of the local currency against the dollar last year also eroded the value of investments.

After the collapse of US investment bank Lehman Brothers Holding Inc., markets across the world went into a tailspin. In India, the Sensex shed 52% in 2008 as foreign investors pulled out $13 billion from Indian stocks to meet redemptions in their home markets.

The fall in the assets of India-focused hedge funds, or those that invest a majority of their corpus in India, is even sharper, according to Eurekahedge data. Assets under management of these funds have fallen from $7.86 billion at the end of December 2007 to around $2.1 billion now.

Since then, however, FIIs have returned to India, pumping some $12 billion into the markets so far this year on hopes of economic growth. Among the 14 or so $1 trillion-plus economies, India is predicted to grow at the second fastest rate. The optimism has boosted the markets, more than doubling their value, with the MSCI India index, a benchmark used by foreign investors, increasing by 113% this year, the fastest among major markets.

But hedge funds do not seem to be buying that story.

“There has been a significant deterioration in the business model,” said the head of a Singapore-based India-focused hedge fund, who didn’t want to be identified. “Investors have got pickier after the Madoff Ponzi scheme. The pool of capital has been reduced because the ability to leverage capital is no longer there.”

In March this year, Bernard Madoff, a former chairman of the Nasdaq stock exchange, pleaded guilty to fabricating gains on assets his firm was managing, leading investors to be wary of hedge funds.

Also, with the credit crunch, banks are no longer ready to lend money to invest in stocks, reducing leverage capabilities.

Indian regulators are likely to view this development with relief, especially after taking steps to stem the flow of so-called “hot money” in late 2007. After the Sensex rose seven-fold between 2003 and 2007, the regulator banned some instruments fearing their disruptive effects on markets.

Typically, hedge funds invest in India using participatory notes (PNs) or derivative instruments. Such notes accounted for a major chunk of the $17 billion that was invested by FIIs in 2007. From accounting for less than 20% of total assets managed by FIIs, PNs rose to around 55% in June 2007, prompting the Securities and Exchange Board of India (Sebi) to ban them in October that year.

Despite Sebi reversing the ban in the wake of the credit crunch, investments through PNs account for some 17% of assets managed by FIIs now, which to many people is a clear indication of the reducing exposure of hedge funds.

At the height of the bull run, Tudor Investment Corp., Lloyd George Management Inc., Farallon Capital Management Llc, Raj Mishra’s Indea Capital Pte Ltd, Tree Line Investment Management Ltd and Arshad Zakaria’s New Vernon Capital Llc were all reckoned to have had India portfolios worth upwards of $1 billion, according to several people familiar with the matter. Mint couldn’t ascertain this independently or reach out to all these funds for confirmation.

“Hedge funds are no longer a force to reckon with,” said Ullal Ravindra Bhat, managing director of Dalton Strategic Partnership Llp, an FII.

Indeed, the single largest category of funds investing in India now is exchange traded funds (ETFs), some people say. According to a 17 August report from investment bank Credit Suisse, at least a quarter of the flows into India since March are from investors in this category.

“ETFs are better” because they take into account a larger picture of the economy and markets, said Bhat. “They will continue to stay invested if the relative attractiveness of India continues.”

Source: Livemint

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