Hedge funds that have set up shop in places like Singapore and Hong Kong generated 30 per cent of all reported commissions earned by brokers over the past 12 months on trades of Asian stocks, according to recent research from Greenwich Associates.

'Large hedge funds from the United States and Europe are looking to diversify both in terms of strategy and geography,' says Greenwich Associates consultant John Feng. 'As a result of the entry of these actively trading investors and the growth of regional hedge funds focused on Asia, the amount of equity commissions generated on trades of Asian shares has increased by 20 per cent in each of the past two years.'

These comments are based on Greenwich Associates' 2005 Asian Equity Investors Study. A new Greenwich Report presents the results of this research, including key findings on hedge funds' growing influence in the region, expected rates of return on equities from countries throughout Asia, the use of portfolio trading, and compensation levels of Asian equity professionals.

Higher turnover driven by growing hedge fund activity

In terms of Asian equity assets under management, the typical hedge fund examined in the Greenwich Associates study maintains a portfolio that is only one-third the size of the Asian stock holdings of the average institutional investor in the region. When it comes to the amount of commissions paid to brokers on Asian share trades however, hedge funds and other types of institutions are essentially equal.

Due to their high levels of portfolio turnover, the global and regional hedge funds that are arriving in Singapore, Hong Kong and other Asian trading centers in ever increasing numbers are generating a disproportionate amount - about 30 per cent - of the total commissions that brokers are earning trading Asian stocks. 'While a robust new issues market has provided a boost to commission levels, the largest part of this growth can be attributed to the trading volumes generated by these hedge funds,' says Greenwich Associates consultant Jay Bennett.

Total equity commissions generated by institutions based in Asia grew to USD900 million for the 12 months leading up to third quarter 2005, up 20 per cent from the same period in the previous year. The increase is all the more impressive when viewed in light of the downward trend in equity commission rates, which have fallen by two to three basis points for major markets in Asia over the past two years, and is a clear indication of sharply higher turnover.

Positive outlook on market returns, albeit more cautious than the past

All told, 2005 represented something of a mixed bag for Asian equity markets in terms of overall performance. While institutional investors remain optimistic about performance in the region in the coming year, new data from Greenwich Associates reveals that a hint of caution has begun to set in.

'For the past two years, institutions' expected rates of return on Asian equities have averaged between 10 and 15 per cent,' notes Feng. 'This year, we see expectations falling in the lower end of that range, which is still robust relative to many other major markets, but is slightly less bullish than we have seen in the recent past.'

Asian institutions' expected rates of return for the coming year on stocks from the region range from a low of 7.5 per cent for India to a high of almost 11 per cent for Taiwan. In addition, expected returns for Hong Kong, China, Singapore and Korea fall into a remarkably narrow range between 9 and 10 per cent.

'At the lowest end of the range, in India, the overall average expectation is dragged down by a considerable minority - about 25 per cent of investors - that expect negative returns from Indian shares,' says Bennett. 'Conversely, Korea stood out in having the highest proportion of investors expecting very strong returns, as almost 15 per cent of institutional investors say they anticipate that returns on Korean shares will top 20 per cent again for the coming year.'

Portfolio trading grows, but electronic trading still in infancy

Asian institutions have been slower than their counterparts in other markets to adopt low-cost trade execution alternatives such as direct market access systems. According to the latest Greenwich Associates research, Asian institutions execute nearly 85 per cent of their total trading volume via single-stock trades with a broker sales trader.

Most of the business diverted away from broker sales traders has been directed to portfolio trading, which accounts for about 13 per cent of total Asian equity trading volume.

Non-algorithmic direct market access trades (DMA) make up just 3 per cent of Asian institutions' equity trading volume, and self-directed algorithmic trading business accounts for just 1 per cent of total volume.
By contrast, institutions in the U.S. have raised their DMA and algorithmic trading to 18 per cent of their total volume.

Only about one-in-10 Asian investment managers (excluding hedge funds) say they actively use DMA systems for their singlestock trading business. However, several trends suggest the potential for considerable growth in DMA and algorithmic trading in Asia. For starters, half of hedge funds are already using DMA for their Asian share business.

Further, Asian institutions that experiment with direct market access seem to use the systems just as much as institutional users in other markets. 'While direct market access is still in early stages among Asian institutions overall, funds that use the systems tend to execute about 15 per cent of their total trading volume via DMA, whether they are in the United States or Asia,' says Feng.

Asian institutions are on a similar footing with their US counterparts when it comes to the use of portfolio trading for client business, excluding proprietary trading or retail volume.

'More than half of Asian institutions are now using portfolio trading,' says Bennett. 'Furthermore, those that do use these systems have increased the portion of their total trading executed through portfolio trades from 19 per cent in 2003 to nearly a quarter in 2005. Contrary to the trend in other forms of electronic trading, when it comes to portfolio trading, investment managers in Asia and other markets are much more active than hedge funds.'


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