Gartmore's Japanese long/short equity AlphaGen fund was one of the firm's top performers last year despite market conditions that hampered the strategy. The US dollar and yen classes returned 17.1% and 15.9% for the full year 2003.
John Stewart manages the fund from Tokyo. He says that in addition to challenges for the long/short equity strategy generally, liquidity in the Japanese market is very low, with most foreign investors sitting on the sidelines.
A trade the fund made last year exemplifies the way it is managed, says Stewart. "We became interested in the re-emerging Chinese demand theme following a visit to a steel company," he says. This led to the managers researching and visiting companies they thought might benefit from this theme. "After a very slow first quarter we were seeing demand pick up and so we thought who else is likely to benefit from this trend?" says Stewart.
One of the companies the fund identified was Hitachi Construction Machinery. It bought its stock in early July at around ¥875. The firm was benefiting in two ways, says Stewart. "First, they were relatively early and relatively well positioned in terms of benefiting from the demand you were seeing in China. But, also, and find good opportunities to buy and sell. Last year, even poor companies saw stock price rises in a broad and indiscriminate market recovery.
Event-driven strategies may do better in 2004 than last year, in particular merger arbitrage and convertible arbitrage. At the end of 2003, convertible arbitrage and merger arbitrage were up 9.4% and 9.9% respectively, according to the Hennessee Hedge Fund Indices. "I think we'll see double digits [for merger arbitrage] in 2004," says Gradante.
If the merger last year between Fleet Boston and Bank of America and, more recently, that announced between JPMorgan and Bank One signal the return of sizeable M&A deals, more opportunities for merger arbitrage will arise. Jones says: "The confidence levels of decision makers are this is what made it slightly more interesting, part of that demand from China was actually for second-hand equipment. And they [China] were actually buying a lot of second-hand equipment from Japan."
This meant that Hitachi Construction Machinery was set to see a pick-up in demand from China as well as from Japan where those that had been selling second-hand equipment were in need of new machinery. Yet the company had low valuations because the market didn't feel it would grow, says Stewart. "The shares performed fantastically well and we got out of the position in late August at ¥1,290 because you were beginning to see signs of a slowdown in China."
Improving liquidity
The Chinese authorities were worried about the rate of economic growth and regulatory changes were implemented to try to slow the market. At this point, Stewart says: "We felt that expectations had got so high [and]...we felt there was a risk that you would see the shares sell off."
The outlook for the fund and the long/short equity strategy in Japan is positive, says Stewart. "Part of it is that the market is going up but the real point is that there's a lot more liquidity in the market." He adds: "Fundamentals are driving share prices and there's a lot less short-term volatility.