Remedies for the Asian Flu
By J.C. Louis
The Asian collapse of late 1997 and early 1998—followed by a strong but brief rebound since—has given many investors motion sickness, and many have opted to get off the roller coaster altogether rather than risk losing their lunches once again. But some think that Asia is ripe with opportunity, and that those who understand the nuances of the Asian markets can reap huge rewards in 1998 and beyond.
The symptoms of the Asian flu suffered by American investors were the result of hyperglobalization on the part of American companies during the past four or five years. With increased globalization, naturally, came an increase in correlation, so diversification became a difficult proposition. Nine months ago, there were already signs of trouble. A lot of U.S. companies in Asia began closing out investment and trading accounts—primarily CTA and hedge fund accounts opened in dollars—out of a need to repatriate cash. When the currency markets started collapsing, these accounts were quickly shut down to get access to cash. Most of the money that fled Korea was from merchant banks, six of which shut down as a result of the contraction in liquidity.
Those early warning signs prompted savvy U.S. investors to embark on a flight to quality, which drew the attention of big institutional traders. Certain people, including hedge funds and proprietary or money center banks, began trying to take advantage of increasingly huge capital movements by shorting the market using financial futures or currencies. "A few red flags went up once those flows began,” says Peter Karpem, a hedge fund and managed futures consultant. "They were the second wave, behind the sophisticated ruling families in the region, whose overseas perspective is entirely different from that of a U.S. investor. Lacking the perspective of off-shore investors, few U.S. investors saw [the imminent crisis] coming.”
|"Managed futures have taken a dip, because they were supposed to provide portfolio insulation and
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Once the cash exodus began, it quickly snowballed, exposing many futures investors who thought they were protected. For years, the managed futures industry had held that managed futures were negatively correlated with equity markets and hedge funds, but it turned out that negative correlation was more a myth than the reality for investors. In the era of hyperglobalization, diversification is becoming more and more difficult to achieve. "Whatever the economic consequences,” admits Brian Cornell, senior vice president of Managed Funds, "managed futures have taken a dip, because we were the ones who were supposed to provide portfolio insulation and did not.”
But many think that managed futures, while not perfect, still provide the best mechanism for diversification these days. "Traders and investors should remember,” asserts Karpem, "that managed futures are a vehicle that achieves diversification by [a trader's] trading style rather than simply because it uses interest rates, currencies and commodities as asset classes.” And the Asian crisis has shown that the myth of equity market neutrality has been blown away. In contrast to managed futures, which combine a long/short posture with no bias, hedge funds and other entities concentrating on equities and deploying so-called neutral strategies can actually be more biased to the long side.
Despite increasing market correlation around the world, however, some think the Asian crisis was overblown. Asia is in some ways a local phenomenon, like the savings and loan crisis was in the United States in the mid-1980s. "It got bigger press than it deserved in the rest of the world,” says Bucky Isaacson, president of Futures Fund Consultants. "Of course Japan and Korea are getting a lot of press, but even they are not as bad as we have expected.”
Many investors realize that Asia is not a monolith, and that a country-by-country assessment is the best means of evaluating the region. In Taiwan, for instance, there was little impact from the crisis, and the market there remains intact. In Japan, meanwhile, U.S. futures traders are largely absent, out of the fear of financial instability of small and medium-sized futures clearing merchants because credit has become an issue. Yet volume at large FCMs such as Mitsubishi and Itochu has not dropped off significantly. Malaysia and Indonesia were not at the stage where they were significant players in the futures group. And it appears as though Korea will sort itself out in the next few months.
Caution, patience and sophistication are the three best approaches to the Asian markets these days. Given the short-term nature of futures trading, traders use the technical instead of the fundamental to decipher the noise. But traders also realize that fundamentals tend to rule the general price direction. "A long-term player will look at the fundamentals to determine whether a disruption like Asia is an anomaly requiring portfolio adjustment,” says Cornell. But merely studying the fundamentals of an economy isn't the best solution for everyone. Given those economies, the gravest effect is on currencies and interest rates, so naturally that is where good short-term traders are going to concentrate, since they tend to flock to volatile markets. Indeed, the implosion of the Asian economies has presented a windfall opportunity for volatility-hungry traders.
Traders aren't the only people poised for success in Asia. There are already signs that foreign money is turning around and getting aggressive about bottom picking in the region. Players such as Goldman Sachs and George Soros have returned to Asia in force. Isaacson sees a golden opportunity for big funds. "We're getting calls from Chicago fund managers, and we're telling them to go over to Asia and raise money. When things get bad, a lot of managers cut back on marketing. We're telling them to do just the opposite—to develop ties to market managed futures and fund products. For instance, we're seeing a $70 million bloc of capital coming out of Malaysia allocated to foreign exchange traders in local and U.S.-based markets.”
There are major signs of life in Asia these days. "The opportunity for futures traders is tailor-made, because markets that become extended in either direction tend to boomerang back,” says Bruce Terry, president of Marathon Partners. "For months, the global markets have moved in a coiling manner, in need of an event that would act as a catalyst to get them moving. The Asia crisis has proved to be that and more. The large economic dislocations, accompanying deflationary forces and shifting capital flows are creating a new dynamic in the marketplace.” By March, the equity markets had bounced back in force. And most important for traders, volatility has increased in the region. For many futures traders, the Asian flu has been little more than a 24-hour virus.