An Institutional Affair

Financial markets around the world have been a quivering mass of uncertainty of late. In particular, equity markets. It has been quite the norm the past month for the Dow to lose 2% in one session only to recover the losses the next day.

Here in Asia, the swings have been even more extreme, for example, South Korea’s KOSPI plunging by 6% for the day, only to make up for it and then some the following week.

Traders and seasoned investors aren’t sure whether to laugh or cry over this state of affairs. What more, the ordinary Joe who is not even sure what he’s invested in. I asked my uncle (he works for a major airline) the other day where his savings were invested. His answer, “Oh, in some pension fund and insurance.” Yes, but what was the pension fund invested in and what sort of insurance? He didn’t know.

The reality is, that many people do not understand financial markets or the services and products they provide. Instead, these people choose to do what the majority of investors across the globe do – put their money in large institutions like pension funds, mutual funds and insurance companies.

Now, have you ever wondered how these funds and companies invest the capital they have? Many a time, these institutions in turn, invest in and/or through other entities like hedge funds and mutual funds.

So, you put your money in say a pension fund that promises to grow your wealth so that you can retire comfortably, but you’re not quite sure what you’re invested in. The fund in turn gives your money to another fund that invests it in stocks you’ve never heard of. Have I confused you enough yet? Well, for this week’s A Fund Affair, I thought it would be ‘fun’ to take a look at a fund that services only institutional investors.

The Fund


The Enhanced Investment Products Company was founded in 2002 by a team of former employees of Jardine Fleming in Hong Kong. EIP manages a series of Asian market index funds that provide institutional investors with the opportunity to invest through exchange-traded funds in Asia. An enhancement component is provided in the form of the EIP Overlay hedge fund (a market neutral Asia ex-Japan fund), which has a captive stock lending arrangement with the index funds, in return for a share of the positive performance of the hedge fund.

Basically, the EIP Overlay Fund is a two-tiered fund structure. There are eight single country Asian index funds managed by the Bank of New York. The index funds track markets in China, Taiwan, India, Malaysia, South Korea, Indonesia, the Philippines and Thailand.

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These eight funds are regular exchange traded funds benchmarked to the MSCI Emerging Markets Asia Index. So if your pension fund invested $10 million dollars in the Korean Index Fund at the start of the year, your fund would have gained 31.4%, and vice-versa if the Korean market had suffered losses.

The kicker, or the enhancement, so to speak is the symbiotic relationship these index funds have with the EIP Overlay hedge fund. The hedge fund is allowed to borrow stocks from the index funds, not for a stock-lending fee, but for a 25% share of any profits generated from the utilization of the stock. Any such returns are paid half yearly back into the index funds.

This means, that the EIP index funds, have the possibility of outperforming the index they are tracking. If the hedge fund makes losses, the investor will get the same performance as the MSCI -- there is no pay-down. Profits are paid down to the index fund, but losses are accrued to the hedge fund only.

The hedge fund and the eight single country funds are in the same protected cell company but have no cross liability. Separate NAVs are published for each fund.

Rory Macdiarmid, chief operating officer for the EIP Overlay Fund says, “Typically we’re looking at the enhanced index fund to outperform the relevant index by between 100 – 200 basis points a year. We’ve done significantly better than that. Last year, the India fund outperformed (against MSCI Index benchmark) by 3.83% and the Taiwan fund outperformed by 2.98%.”

The EIP Overlay Fund caters to essentially two kinds of investors. “We have the index investors are big institutions – pension funds, insurance companies etc. Hedge fund investors could be anybody, but in our case, it’s typically family offices across Europe and the U.S., high net worth individuals, the sort of people you’d expect to invest in hedge funds.” Macdiarmid explains.

In short, the hedge fund appeals to the more aggressive and sophisticated high net-worth investor. These investors are attracted to the facility of borrowing stocks at no cost and minimal recall risk, in markets like Thailand and South Korea, that have yet to reach a level of complexity that enables efficient stock borrowing.

The index funds, which track emerging markets in Asia, attract big institutions with a large investor base, looking to make country allocations in their portfolios that provide reliable outperformance in comparison to active fund management on their own part.

So long as the index markets are performing well, investing institutions make good returns, with the extra possible return enhancement in the form a share in the hedge fund’s profits. But in the end, it really all boils down to whether the emerging markets perform well, or otherwise.

Which brings us back to the roller-coaster ride Asia’s been enjoying the past few weeks. Can funds like EIP stay in the black in crazy situations like now? Your pension fund and insurance company sure hopes so.

But in times like this, I am drawn to Heisenberg’s Uncertainty Principle which states that the more precisely the position (momentum) of a particle – or in this case market – is given, the less precisely can one say what its momentum (position) is. Who would have thought quantum physics could be applied to the stock market?!

The EIP Overlay Fund has a net target return of 12% per annum. As of 31st July, it is up 14.67% year-to-date, and since inception, is up 55.2%.

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