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Army Yan, head of research and managing director with fund of hedge funds manager K1 Group in Hong Kong, says the K1 Fund Allocation System develop

Army Yan, head of research and managing director with fund of hedge funds manager K1 Group in Hong Kong, says the K1 Fund Allocation System developed by the company’s psychologist founder has enabled the flagship K1 Global Fund to achieve consistent and stable returns since the strategy was launched in 1996.

HW: What is the background to your company?

AY: K1 Group is a fund of hedge funds manager whose investment products are managed according to the K1 Fund Allocation System, developed by the company’s founder, psychologist Helmut Kiener, in 1996. Our investment strategy delivered a cumulative return of 711.47 per cent between 1996 and the end of 2008, and the firm currently has nearly USD1bn in assets under management.

HW: Who are your key service providers?

AY: We use various firms for our different products, including PNC as administrator, PricewaterhouseCoopers as auditor and HSBC as custodian bank.

HW: What is your investment process?

AY: The K1 Global Fund is based upon the K1 Fund Allocation System developed and applied since 1996 by Kiener. It consists of a semi-automated programme that provides exact orders of action for capital allocations in alternative investments applying stochastic and statistic parameters.

Each potential target fund must comply with at least 80 per cent of various quantitative criteria and is judged according to a rating system in which the first two criteria, at least two years’ real time performance record and at least 80 per cent positive months, count double.

In addition, the maximum drawdown should not be higher than two and a half times the average monthly gain, the Sharpe ratio should be at least 1.5, and the correlation with other components should not be higher than 0.2.

As an important indicator for the balance of the portfolio, the fund should trade in at least three different markets, proof of results should be provided in statements of account or through an auditor’s report, and the fund should have more than EUR100m in assets under management.

Qualitative analysis of the portfolio manager covers the experience of the personnel, analysis of the IT systems used, operational control and reporting process, the methods applied to limit losses, and the references of the managers, auditors and legal advisors involved.

The general investment principles of the K1 Global Fund stipulate that it should invest in at least 20 and not more than 100 target funds, it should invest not more than 10 per cent of total assets in any one single fund nor more than 25 per cent is a particular investment strategy, and that at least 50 per cent of underlying funds have monthly liquidity.

HW: How has your portfolio of hedge funds performed?
AY: Since its launch in 2006 the K1 fund has suffered only one down year, a loss of 9.74 per cent in 2008, after 12 consecutive years of gains, and has suffered just 32 losing months out of 156. Over the five years to the end of November it recorded an average annualised return of 7.76 per cent and average annual volatility of 7.95 per cent.

HW: How many funds are in your portfolio? Which strategies do they represent?

AY: We invest in more than 75 target funds covering almost all strategies, including long/short equities, distressed, credit, macro, CTA, convertible arbitrage, fixed-income arbitrage and event-driven.

HW: What makes a manager or strategy special enough for you to select him?

AY: The manager has to be qualified according to the selection criteria of the K1 Fund Allocation System and also must be the best in the respective sector.

HW: What are your criteria for removing managers from the portfolio?

AY: When a manager violates our selection criteria and fall below the minimum level of 80 per cent, they will be removed.

HW: How many managers do you have on the substitutes bench?

AY: We have a watch list of between 150 and 200 funds.

HW: What events do you expect to see in the alternative investment sector in the year ahead?

AY: Although the hedge fund industry has undergone difficulties in 2007 and 2008, we saw performance rebound in December and January. We also see managers adapting to the changing market conditions. Low interest rates will help the liquidity of the market in the coming quarters. We see the downturn leading to consolidation of the sector, which is positive, enabling the strongest managers to deliver enhanced performance in the future.

HW: How will these developments impact your own portfolios?

AY: We have increased our selection criteria and also revised our due diligence process to make sure the managers we like are diligent and perform to their best.

HW: What is the split of your assets between institutional and private clients?

AY: We have less than 25 per cent institutional money, with more than 75 per cent coming from private clients. We provide equal investment opportunities to different categories of investor.

HW: What differentiates you from other managers?

AY: We have been in the market since 1996 using the K1 Fund Allocation System developed in-house, and over those 13 years we have been through a wide range of difficult and varied markets.

HW: What are your views on risk management?

AY: From our point of view, risk is to be managed, but we do not like to put investors’ money at risk. Our target is to deliver annual returns of 8 to 12 per cent with minimal volatility. We see some managers aggressively taking market risk to increase their performance, which is not in line with our style. When we don’t see good and safe investment opportunities, we will just lower our exposure.

HW: Are investors’ expectations moving towards capital preservation?

AY: Investors are more prudent than before and we have been managing our funds in capital preservation style. We have no problem with this since this is our natural style.

HW: How do you distribute your funds?

AY: We distribute our funds through distribution partners including banks, private banks, insurance policies, financial institutions and securities houses.

HW: Do you foresee problems in raising mandates from investors through 2009? If so, what factors will help drive investors back to your funds?

AY: The market has been difficult with the stock market crash in 2008. The wealth of high net worth clients has been shrinking, and it is now difficult to raise large mandates. However, since our fund is very diversified with stable performance and we have had a good start to 2009, with the fund up 2.5 per cent, we are seeing some investors starting to come back. We believe the situation will get better in the second half of the year.

HW: Finally, are you planning any launches?

AY: We are in discussions with partners in Korea and Japan this year to launch public offerings of funds in the respective countries, and we are looking closely at the distressed sector, where we see lots of interesting opportunities.

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