SHK Fund Management, an asset-management arm of Hong Kong's Sun Hung Kai group, has added a new fund to its platform of alternative investments for its Asian clients of high-net worth and institutional investors. After searching for an asset class that offers decent returns, low volatility and low correlation to others, the firm settled on asset-backed finance.
It chose to work with investment advisor Eden Rock, a London-based manager of multi-strategy fund of hedge funds with a large exposure to asset-backed lending funds, says Jacqueline Ho, managing director at SHK. The SHK Asset Backed Finance Fund aims to return 10-15% annually with only 3% volatility.
Eden Rock was established in 2001 and asset-backed lending (ABL) strategies have always been the biggest hedge-fund sector in its portfolio, says Edward Horner, managing director. "We're really becoming more like a fund of ABL funds, so we decided to launch a dedicated ABL product," he says.
The resulting offshore product has been replicated for SHK but tailored to take out certain underlying structures that the firm wasn't comfortable with, such as Pipes (public investment in public equity), and to provide for more exposure to fixed-income strategies within the fund of funds, to provide a measure of stability.
Over 80% of Eden Rock's exposure is to managers in the United States, where ABL is most advanced, although markets such as the UK and the Netherlands are developing quickly. The risk/return profile varies among individual funds but all involve short-term, high-margin loans to a company using its assets as collateral, which generates cash to meet the company's immediate financial needs. Such companies may find it difficult to obtain loans from banks because of a default in their credit history; or their business may require fast financing that the company is willing to pay for, such as for a bridge loan to secure a fast-moving property.
This does not represent a credit risk. Indeed, defaults can actually help the investor, because it has secured the collateral, which may be worth more than the principal. Rather, the primary risk is legal. "The fund managers must ensure the documentation is watertight," Horner explains, "so that these loans really are over-collateralized by a real asset that the manager can seize in the event of a default." Eden Rock's biggest job is to understand how underlying managers respond to default situations.
Because the ABL business isn't about credit or interest rates, it has a very low correlation to other asset classes. "We've been operating for 39 months and have not had a down month," Horner says, adding that asset-backed lending has been going on for centuries but only in the past two or three years has been transformed into a hedge fund strategy.
These individual strategies vary in risk (some examples of collateral include accounts receivable, entertainment assets, cars, property, commodities, inventory and insurance), so Eden Rock ensures a diversified portfolio to mitigate against a specific disaster. On this basis, Horner argues, the worst-case scenarios require downturns of Great Depression severity, in which not only do companies default but their collateral's value is also destroyed.
"Most of our clients are conservative high-net worth individuals," SHK's Ho says. "ABL has been working for a long time, but there are only two ABL hedge funds with a track record of more than five years. We realized there is a capacity limit and didn't want exposure to a single strategy, so we teamed up with Eden Rock."
SHK manages about $550 million of assets, including strategies focused on fixed income, credit and restructuring stories. The ABL product's fund administrator is HSBC, while PricewaterhouseCoopers is the auditor and Deacons the legal advisor.
