Hedge Funds Investing in India

HedgeFund.netIn early 2008, HFN launched a series of benchmarks to trackperformance of hedge funds focusing their investments incountries or regions garnering an increasing amount ofinterest. The country specific benchmarks included the HFNBrazil, Russia, India and China Averages. At the time of launch,expectations were high for India focused funds. However, thebenchmark has shown them to be among those most impactedby the financial crisis and the country more dependent uponsustained global growth than previously expected.The HFN India Average ended 2008 -56.56% behind only theHFN Russia Average,-61.20%, for worst performing hedge fundclassification tracked by HFN. In 2009, through February, Indiafocused funds have surpassed those investing in Russia to bethe worst performing group. The HFN India Average is -9.93%year-to-date (YTD) which even trails the country’s primaryequity benchmark, the BSE SENSEX.Most likely due to poor performance and fund liquidations, thebenchmark has experienced above average turnover as 19% ofthe original benchmark funds have exited the HFN database.The total number of funds in the HFN database has fallen only13% from its peak in October 2008. Despite being higher thanaverage, India fund turnover is significantly better than otherpoorly performing fund groups. The HFN Russia Average, whichwas launched at the same time, has lost 38% of its originalcomposition and total fund products in the benchmark havefallen from 61 a year ago to 48 through February 2009.Another victim of the financial crisis could be the BRICacronym itself, or that Brazil, Russia, India and China shouldbe classified together as growth leaders. It was obvious duringthe strong markets through 2007 that each nation benefitedfrom global growth and the resulting commodity anddevelopment boom. Their mutual success was a result of theirunique positions to benefit from strong economic trends. Eachnation has had to face the economic fallout with a differing setof weaknesses which has exposed them to entirely differentscenarios for resurrecting growth.The remainder of this report will focus on the performance andgrowth trends of hedge funds investing primarily in India,including a comparison with funds investing in the othercountries formally known as the “BRICs”. The size and healthof the hedge fund industry and the exposure funds are willingto accept to the country’s economic development may have animpact on India’s recovery.Total Asset LevelsAt the end of February 2009, HFN estimated that total assetsin hedge funds investing primarily in India’s markets were$6.10 billion. Asset levels peaked at the end of 2007 at anestimated $18.74 billion, meaning India focused hedge fundassets have fallen 68% during the financial crisis. During thatsame period, the HFN India Average fell -60.87%. This is aninexact, but reasonable way to illustrate that performance hasaccounted for the vast majority of the reduction of Indiafocused hedge fund assets.Given the level of losses, we would have expected a higherlevel of investor redemptions. During the same time frame,broad hedge fund assets fell 39%. The difference being thatalmost half of the broad industry’s asset reductions came fromredemptions and liquidations. This is evidence that, for betteror worse, investors in India focused funds have not redeemedat as rapid a rate as the broad industry.Correlation of ReturnsSince the end of 2007, global markets have shown muchhigher levels of correlation than many had anticipated waspossible. Despite the underlying domestic circustances beingvastly different, emerging markets have exemplified this highlevel of correlation. In Figure 4/5 the correlations of monthlyreturns are compared for the time periods of two years prior tothe onset of the financial crisis and the fourteen months since.During the first period, the correlation of monthly returns forIndia focused funds to other emerging markets was relativelylow. India funds showed higher correlations to broad hedgefund performance than to Brazil, Russia or China focusedfunds. Since the beginning of 2008, the correlations increasedmost dramatically to China, yet actually decreased to Russiafocused funds. One possible explanation for this is the similar,high level of influence foreign investment had on the Chineseand Indian equity markets. Correlations to funds investingacross broad EM and to the broad industry benchmarkincreased only slightly.Comparisons between the India Average and the SENSEX alsoshow interesting points. If we look farther back than the twoyears prior to the crisis (1997 through 2007) the correlation ofmonthly returns between the two was only 0.58, an indicationthat before the run up to the crisis, India focused hedge fundslikely took a much more specialized approach to investing inthe region. In the two years prior to the crisis, when Indiafocused hedge fund assets increased more than 350%,fund/SENSEX correlation rose to 0.83. In the wake of the crisisthis correlation increased to 0.96.Percentile Ranked ReturnsPerhaps the most interesting aspect of percentile ranked fundreturns is evident when Figure 6 is compared to the samechart from the prior report in March 2008. At that time therewere 13 India focused funds with greater than $100mm inAUM, compared to only 3 now. This does not take into accountfunds which do not report assets to HFN, but it does clearlyillustrate the destructive losses.Going ForwardThe conceptual fault of the “BRICs”, thinking of these nationsas one highly related group, became clear in the aftermath ofthe crisis. While Russia had tried to diversify from a highlycommodity dependent economy, the faults in its bankingsystem were exposed. Brazil appeared to best solidify itscapital structure and diversify its economic base while Chinahas used its massive currency reserves to stem more severeeconomic decline. India on other hand had benefited fromglobal corporate growth and as a place of internalreconstruction driven by FDI. This combination was severelyhurt by reduced leverage in the global financial system andexposed a government less capable than China to spend tosupport growth.The $1 billion accounting fraud at Satyam Computer, thoughtto be one of the country’s leading businesses, uncovered at theend of 2008, will likely slow the speedy return of outsideinvestment. The future of hedge funds investing in Indiadepends, in part, on the ability of the Indian government tostimulate foreign investment. While steps have been made bythe government, including reducing bank cash reserverequirements and increasing rupee limits on corporate bondpurchases by foreign investors, unfortunately they have nocontrol over the ability of outsiders to generate the capital toallocate. This implies that perhaps India was more dependenton a rising global economy than initially thought and strongperformance from the countries equity markets may not returnuntil there is a clearer global economic picture.