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Hedging their bets

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Dec 14 – 20, 2015.
Published on The Edge Markets – Part 1, Part 2and Part 3 on Dec 21 – 23, 2015.

For Devan Linus Rajadurai, wealth management and investing runs in his blood. His late grandfather

Kok Ah Too and mom Kok Wai Leng practised a set of investing principles that helped to grow and preserve the family wealth for eight decades.

Today, Devan uses the same principles at Malayan Traders Capital, which he co-founded with long-time friend Aaron Yew in 2012. Devan is chief investment officer while Yew is CEO of the company. Last month, its sister company, MTC Advisors Sdn Bhd, became the first licensed boutique fund manager in the country.

Devan’s grandfather was a renowned investor and partner at Malayan Traders & Co Sdn Bhd, one of the largest stockbroking firms in the 1960s. But he had started investing when he was just earning a school teacher’s salary. With a wife and seven children to support, he put aside what money he had left over to invest in stocks.

After researching a number of companies, Kok identified two tin companies — Berjuntai Tin and Selangor Dredging — which provided great returns. He strongly believed in the potential of these companies, so much so he mortgaged the family home and used the money to invest.

“He was using the concept of leverage, which is the strategy our hedge fund uses now. He calculated that the tin mines were paying a dividend yield of roughly 20% per annum, and mortgaging his house at a 4% rate at the time meant there was opportunity for arbitrage,” explains 30-year-old Devan.

Kok’s investments paid off handsomely. In just a few years, he paid off his housing loan and managed to create a healthy income stream for himself. “He never sold his stocks. He would use the dividends to buy more of the stocks. His rule was to stay invested,” says Devan.

In 1960, Kok was invited to be a partner at Malayan Traders & Co. He helped to grow the company into one of the largest stockbroking firms in the country. He also became the first Malaysian to be chairman of the then Stock Exchange of Malaysia and Singapore.

In 1972, his daughter Wai Leng joined the company with the intention of being groomed to take over the family business. Together with her brother, they ran the company until it was sold in 1985. The reason for the sale? “They didn’t want to manage a business. They wanted to focus on investing and growing the family wealth. So, they managed their money as a family office instead,” explains Devan.

When he graduated with a bachelor of commerce degree in accounting from Macquarie University in 2007, his mother asked him to help out with the family investments. “I had studied accounting and showed an interest in investing. I also dabbled in investing when I was younger, but nothing serious. My mom had been managing the local investments, so she asked if I could help her manage and grow our family’s overseas investments,” says Devan.

He adopted his grandfather’s time-tested value investing philosophy, which uses leverage, and applied its principles when selecting overseas investments.

In 2011, when Devan was working at Accenture in Melbourne, he spoke to Yew about starting a hedge fund. “I was in the fund management industry in Australia. We began by asking each other what the other thought about particular companies as investments. Later that year, we started to receive requests from family members and friends to manage their money,” recalls Yew, 30.

“But we knew that managing our own money was very different from managing other people’s money, so we thought if we wanted to do this, we had to do it right. So, in 2012, we began operating Malayan Traders Capital out of Singapore.”

In the island republic, the duo found that a significant proportion of their client base were Malaysians. “That sort of sparked our interest in coming back [to Malaysia]. We realised that Malaysians were looking to invest overseas via hedge funds, but didn’t have access to any here,” says Yew.

Malayan Traders Capital Ltd structured its Absolute Return Fund in the British Virgin Islands in 2012 and moved it to the Cayman Islands in 2014. In 2013, the company set up MTC Advisors in anticipation of getting a licence to operate as a boutique fund manager in Malaysia. MTC Advisors received the licence on Nov 19.

The Securities Commission Malaysia had relaxed its rules in July to allow firms with niche fund management expertise to be licensed as boutique fund managers. The companies would only require a paid-up capital of RM500,000 compared with RM2 million for a full-fledged fund management licence. Under the new licence, boutique fund managers are allowed to manage assets of up to RM750 million and have a clientele of not more than 50 qualified investors.

Since the 1990s, hedge funds have been perceived as risky vehicles that can destabilise markets. In September 1992, currency market speculator George Soros earned the title of “the man who broke the Bank of England” when his company’s Quantum Fund made over £1 billion in profit by short-selling the pound. As a result, the British government was forced to withdraw the currency from the European Rate Mechanism.

In recent times, two more notable cases have made headlines — Long Term Capital Management, which almost caused a global financial crisis with its highly leveraged trades in 1998, and Tiger Asia

Management LLC, whose founder was banned from trading for four years in 2014 when the management admitted to insider trading and share price manipulation.

Yew explains that there is a whole spectrum of hedge funds around the world, but it is only the highly risky ones that tend to get reported. “The term hedge fund is very broad. In recent times, it has been the risky hedge funds that are reported in the media. Some of them do very well, some of them don’t. But there are safe hedge funds, like us. We are a low-risk hedge fund.”

Devan says hedge funds began as a low-risk strategy in the 1950s. “You have to look at history to see what hedge funds actually mean. Hedge funds started out with a very low-risk strategy in the 1950s.

When investing in stocks, famed investors like Alfred Winslow Jones and George Soros would take on opposing positions to minimise and hedge their risks.

“Buffett Partnership Ltd, which Warren Buffett founded in 1956, was actually a hedge fund that practised value investing. Among his many investments were Geico and Berkshire Hathaway, which he took control of after closing Buffett Partnership. He ran Berkshire like a value hedge fund. Seth Klarman of Baupost Group also runs a value hedge fund in the US. George Soros, on the other hand, runs a macro hedge fund, which is considered high risk.”

Devan says what makes the Malayan Traders Capital Absolute Return Fund a low-risk one is the value investing strategy he employs. This is particularly effective in turbulent times.

“Turbulent times present themselves as an opportunity for us as there is a lot of value out there in the markets. Then, we take a little bit of leverage and start investing in these safe companies for the long term,” he says.

“For example, the weak ringgit and low crude oil prices have resulted in the stock prices of certain companies tanking, so much so they came close to their cash value. They may not be able to get the same profit as last year, but when things recover, they will recover as well. So, we picked up some stocks because of this.”

The fact that both Yew and Devan have made “a sizeable contribution” to the fund means that they have skin in the game and are less likely to take on unnecessary risks. “We are an owner-managed fund; we are not employees,” says Devan.

“A lot of hedge funds in the region don’t have significant capital in their funds. They have so many different strategies, which result in inconsistent performance. But when you have your own money in the fund, you have to think first about how you can protect your capital, and then grow it with the lowest possible risk.”

Although Yew and Devan are considered young in this nascent industry, they are optimistic this will not be a disadvantage when it comes to convincing investors to park their money with them. “We may be young, but our strategy is old. Value investing is a time-tested strategy. I implemented this strategy because of the knowledge passed down from my mother and grandfather. In fact, my mom, who is the chairman of the company, still ensures we implement the philosophy,” says Devan.

Focusing on capital preservation

Malayan Traders Capital Absolute Return Fund is an actively managed global equity hedge fund that uses a bottom-up investing approach. It employs the value investing strategy and invests long term in blue-chip companies around the world. “Currently, it is the only hedge fund in the country,” says Devan.

The fund’s benchmark is Singapore’s Straits Times Index and the MSCI All Country World Index. According to its fact sheet, the fund “does not time markets, engage in momentum trading or rely on market forecasts to deliver high risk-adjusted returns”. It is only available to qualified investors with a minimum investment amount of RM500,000. Those who invest via its Singapore office require a minimum of US$250,000.

The fund currently allocates about 40% of its portfolio in US companies, about 40% in Asia-listed companies and 20% in any opportunities they see. “Specifically, the fund looks at solid global companies that are going to benefit from the Asian growth story. We invest in US companies as many of them have expanded globally and tapped into emerging markets like Asia. Also, they are innovation machines. For example, when we made additional investments in Apple in 2012, the company had yet to launch an Apple store in China,” says Yew.

“The 20% will be in whatever opportunities we see. There was a point in time when we invested in

London, then in Australia. That was because we both lived there for more than eight years and know the market very well.”

The fund employs leverage in the form of low-interest US or Singapore dollar-denominated loans (of less than 1%) to invest in these companies to obtain a return. The fund aims to make a return of more than 15% per annum, net of fees. Yew says this strategy is safer than buying into a small-cap company that is very volatile, and has contributed to good returns for the fund.

“It is very similar to property investing. Over the last three years, we have made 20% per annum in US dollar terms. In ringgit terms, we actually doubled our money because the currency weakened,”

In managing the fund, Yew and Devan also use different investment vehicles such as derivatives as a means of buying into companies in markets that are not easily accessible. “We use derivatives such as swaps and options in restricted markets like India, South Korea and Taiwan, which a regular investor does not have access into. We cannot buy directly into stocks in these markets,” says Yew.

The fund is domiciled in the Cayman Islands, which Devan says is typical of hedge funds. “There are multiple reasons why we chose the Cayman Islands. The tax benefit is the main reason why you go offshore to structure your funds. They also update their laws governing hedge funds regularly and make sure the laws are fair to the treaties of every country.”

Hedge funds typically abide by the 2/20 fee structure, which is to charge a 2% management fee and 20% performance fee. The Malayan Traders Capital Absolute Return Fund carries a 1% management fee and a 20% performance fee on the profit above the high water mark of its net asset value. The fund does not charge any sales fees.

“We can afford to charge a 1% management fee because we are uniquely situated in Malaysia. Our operating cost is much lower than if we were located elsewhere,” says Yew.

“We also feel that focusing on the performance fee will be fairer to investors. The management fee will just be enough to cover costs. We should only be making money when our clients do.”

Devan explains how the performance fee works for individual investors. “Let’s say an investor parks RM10 million with us, net of the management fee. If his RM10 million grows to RM11 million, he has made a 10% return. So, we take 20% of that, which is RM200,000. The investor will be left with a profit of RM800,000, so his net return is 8%. He now has a total of RM10.8 million. But the high water mark is RM11 million. If we don’t surpass that amount, we will not take a performance fee. We feel that is fair.”

The company used to disclose its top five holdings, says Devan. “Then we realised that this doesn’t always work. At times, our investors question our stock selection instead of looking at the strategy and how it would work in the long term. But when investors ask, we tell them.”

The fund focuses on capital preservation. To diversify its bets, it holds between 10 and 15 stocks at any time. Devan says the fund will cap its investments at 20 stocks.

“We feel that having this amount reduces volatility substantially. That is what we aim to do as we are not only managing our but other people’s money as well. If we invested in, say, five stocks, we may get returns if we are good. But it is going to be extremely volatile.”

Is there a possibility of losing one’s entire capital in a hedge fund like theirs? Devan says no. “We ensure that the stocks we buy have downside protection. Our diversification in 10 to 15 stocks means that if we get one wrong, we are protected. We also have our own money in the portfolio, so we are motivated to make sure there is capital preservation.”

Yew adds, “The first thing we look at when assessing a company is how much tangible book value and cash it has. If it goes bust, what am I going to get back? We should buy low, so we aim to protect at least 80% of our capital. The most we can lose is 10% to 20% [in the short term while waiting for the stock prices of their holdings to recover], never more.”

Devan explains the valuations that fit the criteria when selecting companies. “We look at those with a price-earnings ratio (PER) of less than 10 times. For price-to-book (P/B), it depends on the organisation. If it has a sustainable high growth rate, then we are okay if its P/B exceeds two times. In Singapore, many property firms trade at a P/B of less than one time. That is like a bargain to us and we will look into them further.”

“There are also other metrics, where we not only look at the earnings but also the actual cash flow of the company. There’s this other ratio called price-earnings to growth [the PEG ratio is a stock’s PER divided by the growth rate of its earnings]. So, a company can be trading at a PER of 20 times, like Google when we bought it, but we knew the company would be a good buy because we knew it was going to grow at 20% per annum. A good indicator is a PEG ratio of below one.”

Wilmar International is another of the fund’s holdings. “Wilmar is a well-managed company. And the beauty about it is that not only are commodities undervalued, the company is also an agricultural player that actually owns the land. Wilmar is a well-run, safe investment, so we can trust that. Valuations are also good,” says Devan.

The fund recently began investing into a Malaysian company, Coastal Contracts. Devan sees the long-term potential of the company, which has inventories and cash and should be able to ride out the downturn in the oil and gas industry.

“Plus, it has a long track record of being a conservative and well-managed company. It is a hidden gem. When you compare it with other players in the industry, this company is in a net cash position,” says Yew.

The fund allows investors to create a self-dividend policy, which is suitable for those looking for a steady stream of income. It allows investors to withdraw a minimum sum of US$10,000 monthly.

As at end-November, the fund held about RM70 million in assets under management (AUM). With the licence, MTC Advisors expects to grow its AUM further.

To extract the full benefit of the hedge fund, Yew recommends that investors have a holding period of at least three to five years.

“We look for high-quality companies that are currently out of favour and buy into them at a cheap price. Most people are short term, so they naturally discount these companies. From our experience, it takes three to five years for a company to double or triple its stock price,” he says.

Malayan Traders Capital aims to go beyond just providing returns to its investors. “Like our logo, our goal is to manage wealth for generations. We want to manage a family’s money not just for this generation but the subsequent ones. We want to build a long-term partnership with that person and family. We see our clients as our partners and want to build that relationship with them.”

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