Asia's hedge funds industry comes of age

As hedge funds focused on Europe and North America labour to achieve lackluster returns, the attention of managers, allocators and investors is turning to Asia, where a combination of vibrant economic growth and increasingly sophisticated capital markets is creating an industry that could be worth USD250bn by the end of the decade.

If Asia was ever the poor relation of the global hedge fund industry, those days are long gone. The assets of Asia-focused funds have grown fivefold over the past three years, from barely USD20bn in 2002 to an estimated USD100bn at the end of last year, and some industry players believe the total could reach USD250bn by 2010. According to figures from Singapore-based research firm Eurekahedge, there were nearly 660 Asiafocused hedge funds - including Japan and Australia - in November last year, an increase of almost 20 per cent from six months earlier.

This remarkable growth rate has been assisted by a convergence of factors, notably the emergence of China as an economic power and the rebirth of Japan after a slump lasting more than 15 years, amid a general economic rebound across a region that now appears fully recovered from the political, economic and financial crisis that afflicted many East and South East Asian countries in the late 1990s.

This is happening at a time when a downturn in hedge fund returns in Europe and North America has prompted investors and managers alike to cast their net more widely in search of alpha. A wave of money, for the most part from institutional investors, has flowed into both the funds of new managers and those of well-established hedge fund firms from abroad that have recognised the increasing importance - and profitability - of Asia by establishing a presence in the region.

Says Peter Douglas, principal of hedge fund consultancy GFIA and the AIMA council member for Singapore: 'Inefficiencies in Asian capital and information markets are creating good returns, and in the near term these returns are being amplified by good market liquidity. Investors should expect both returns and volatilities to be higher, strategy by strategy, in Asia than in a developed market. However, the universe of Asian managers is less and less directional, and increasingly able to capture returns from a wider range of opportunity sets.

'The big trend is the big global USD5bn- plus hedge funds setting up trading and investment operations in Asia. Ochs-Ziff, Rohatyn, Ritchie Capital are already established, and there will be quite a few more of those. The service providers obviously love them, because they're big ticket business straight out of the door. The big global investors like them because they know the names and the people, and that risk management is in place. This will be the most important flow of people and dollars over the next 12 months.'

The arrival of established US or European managers has boosted the development of the region's own twin centres for hedge fund management and servicing, the wellestablished financial hub of Hong Kong and its smaller but faster-growing rival in Singapore. At present more than half of all Asian hedge fund assets are managed from the UK and the US, but many industry participants expect the balance to shift steadily toward centres within the region. Currently GFIA estimates that there are about 500 funds managed from within Asia (out of a total of 750 investing in the region), including not only the established centres but other countries including Korea, Thailand, Malaysia and Indonesia.

This is especially likely, they say, as a combination of experienced professionals coming into the region from abroad and the increasing liquidity and sophistication of Asian capital markets helps to enlarge the investment focus of hedge funds away from long/short equity - usually with a long bias - that currently accounts for 66 per cent of the industry, and multi-strategy and distressed debt, which account for a further 18 per cent, according to Eurekahedge.

The entry of new players into the market and an enlargement of the strategy range may also trigger greater competition in the Asian market for hedge fund administration, which is today largely dominated by three players - HSBC, Fortis and Citco. Unlike in markets elsewhere in the world, there are currently few signs of the emergence of locally-based niche players to take on the global giants.

Experienced members of the hedge fund industry interviewed for this special report caution that it can be unhelpful to view Asia as a single monolithic market when rules governing areas such as taxation of fund managers, permitted investment strategies for pension funds, the ability of retail investors to access hedge fund products, stock borrowing and the use of derivatives often vary from country to country.

Nevertheless, they acknowledge that an overarching trend toward liberalisation of asset management and investment can be identified across the region, and there is unanimous agreement that there is still plenty of room for expansion of the hedge fund industry. The Asian-Pacific region may account for some 15 per cent of the world's aggregate equity market capitalisation, but the region's share of hedge fund assets is barely half that, according to Eurekahedge.

Says Andrew Mascall-Robson, commercial director of Fortis Prime Fund Solutions (Asia) in Hong Kong, 'Economically Asia is booming, the markets are maturing, there is a great deal of interest, and the markets are moving forward, even if they have a bit if a way to go. It's the place to be, which is why everyone's being drawn here as if by magnets. I don't think it would be too foolhardy to predict a figure of USD250bn by 2010.'

By far the fastest growth in assets since 2000 had been in the Greater China region - hardly surprising, Eurekahedge notes, since it has been producing annual returns of more 18 per cent over that period, the best performance of any Asian market. However, some 30 per cent of Asian hedge fund assets are focused solely on the Japanese market.

Mascall-Robson believes that the industry is benefiting from the gradual emergence of a domestic investor base, especially as regulatory or cultural barriers to the use of hedge funds by institutions come down. He says: 'The Asia Pacific hedge funds industry has long been in thrall to the fact that the major parts of its investors were been located outside the region, in Europe. A vibrant domestic investor community makes for a much more healthy capital base. The larger the domestically-sourced asset base, the more stable the industry is likely to be.'

Robert Grome, who is also based in Hong Kong as Asia Pacific leader with the Price water house Coopers Investment Management Industry Group, notes that hedge fund investment by pension funds across the region remains 'embryonic'. He says: 'It's not happening on any large scale.
There is some allocation, but for the most part pension funds are not investing in hedge funds at all.'

However, he does see evidence that the industry is starting to tap local sources of capital. 'Some of my hedge fund clients have attracted some local money,' he says.
'Family offices are increasingly springing up in Asia, which represents a new breed of institutional investor. And there is some pension fund money going into hedge funds from a handful of investors like the Hong Kong Jockey Club.'

Brian MacDougall, executive director of Hong Kong-based fund of hedge funds manager Oria Capital, estimates that as little as five per cent of investment into Asian hedge funds actually comes from the region, and most of that from Japanese institutions. 'Typically investment is coming from funds of funds, family offices and institutions in Europe, which accounts for up to 65 percent of the total, although the US share is growing and probably accounts for some 25 percent.

 'The share of Asian capital is increasing, but slowly. A lot of institutions here are family offices as well - there's a lot of overlap - and they have so much exposure to the region already through businesses and private equity that they're not necessarily looking to make additional Asian investments. A lot of hedge fund interest here comes more from individuals than institutions.' In the same way that US and European investors are diversifying into Asia, he argues, it's logical for Asians to diversify out of the region.

While the influx of institutional money has prompted an increased degree of professionalism among Asian hedge fund managers in terms of compliance and risk controls, MacDougall says that outside investors may not be able to insist on the same requirements for managers that they would expect at home. He says: 'They're not going to find the structure that they would in Europe or the US. Investors coming into Asia have to rethink their guidelines.

 'If they want a hedge fund that's been around for three years and has USD200m to
USD300m - sorry, they're too late. Managers who've been around two or three years with a decent track record are closed, and for many of them, USD200m-USD300m is all they're taking. So investors have to look at funds with USD25m to USD75m, and managers with only six to 18 months' track record. That means spending a lot of time doing due diligence on their past. That's where having relationships within the region is so important, because they must assess the background of the manager, where he came from, what he was doing there, and whether he's qualified to do what he's doing now.'

Grome believes Asian hedge funds are on the verge of a major expansion of their investment scope. 'As the derivatives pool opens up we're going to see more complex strategies,' he says. 'Between 60 and 70 per cent of funds to date have been long/short equity, which is not complex at all, and in.
 
Many cases it's without much in the way of leverage. We'll see a lot more playing of options and contracts for difference, trying to access markets and short stocks or use some sort of derivative such as index options or stock options.

 'As the investable pool becomes bigger, we're already seeing the beginnings of more complex funds. And I don't think the Americans are coming here just to play the equity markets. They've already been operating at a very sophisticated level for 10 years or more, and this is where they have such an advantage. They'll be bringing some of these new products, most of which are the creation of investment banks - and the investment banking presence in Asia is itself several times larger than it was 10 years ago.'

Allan MacLeod, head of hedge funds at Edinburgh-based asset manager Martin Currie, says that constraints on shorting stocks do have an impact on the kind of strategies used by managers in Asia, but argues that long bias is down to bullish equity markets as much as the absence of alternatives. He says: 'In a number of markets you physically can't short, like Malaysia, Indonesia, Thailand and the Philippines, so you're either long or not there at all.

 'The main markets where you can short are Singapore, Hong Kong, Taiwan, Korea and Australia. It's not like the UK, the US or Japan, where you can go long of any stock or short of every stock. That structure lends itself to a long bias. But in the long term, everyone is reasonably bullish about the prospects for Asia, increasingly so for Japan and very much so for China, so you would expect them to have a long bias over time.'

Nevertheless, MacLeod says that Martin Currie's four Asian-focused hedge funds - two investing in Japan using different styles, one covering Asia ex Japan and one Greater China - are able to find both long and short investment ideas. He says: 'At the moment we're net long in all four funds, but for a long time we were flat or net short in Japan. When we launched the Asia fund just over three years ago, there was still a bear market and we were net short for the first six months. As in Europe or the UK, it depends on our view on the market and on individual stocks.'

An increase in multi-strategy funds is already evident, according to Douglas. He says: 'The multi-strategy approach is gaining some traction, understandably, because Asian capital markets are quite constrained, and it enables managers to create more capacity, because they can go to wherever the liquidity is. As a business model, multi-strategy makes a lot more sense. Even some of the big new players coming in are saying: 'There's going to be interesting stuff in Asia, but that interesting stuff will be different from year to year, so we'll take a multi-strategy approach to it.''

Adds MacDougall: 'While hedge funds tend to be long here and it's often difficult to short, that's not to say that they don't provide alpha. You provide alpha here by your relationships. They have to be very good and at quite a high level, and secondly, you must have people on the ground in the area in which you're managing. If we looked at a pan-Asian multi-strategy fund we'd probably run away, because there are one, at most two, who have the infrastructure in the different countries they invest in to add alpha.

 'It's only possible by having people on the ground with the relationships, doing the legwork and going into the companies. In many countries you can't go into Bloomberg and find out what companies have been doing. You find it out by going to visit them, going through their paperwork and looking at their sales, their income, their expenses, and what's in the pipeline. Only then can you assess whether or not the company is worth investing in.'

 

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