Rising stars in the east

The time has come for hedge funds in Asia. Following the emergence of the industry in the US and its recent growth in Europe, Asia is now the rising star of the global industry - in particular vibrant up and coming markets such as India. As a result, increasing numbers of established European and US houses are moving into Asia and setting up shop. Many have tried to manage Asian strategies from Europe and the US in the past, but they've decided that the market is now big enough to justify a local presence.

This trend is partly attributable to the fact that Asian hedge funds have produced greater returns than those in other parts of the world over the past year. Investors are looking for new sources of alpha and believe it is easier to achieve this in Asia. The only downside is that as an up and coming market, Asia is not as sophisticated or experienced as other regions, and there are not many fund strategies on offer. The majority of funds are long/short equity, making it difficult for investors to diversify their portfolio.

Some observers argue that because Asian capital markets are limited in size, hedge funds in the region are in danger of running into capacity constraints, for example in the area of stock lending. They're perhaps forgetting about Japan, which earlier this year shrugged off a USD300m decline in market capitalisation from one week to the next.

There are certainly limitations at the moment to stock lending and to some capital market instruments. Many hedge fund managers who focus on a particular country or region are reaching a point where they feel they have reached their capacity because it is becoming increasingly difficult to find alpha. What they often do is start a new strategy, for example with a Pacific Rim or a more global focus, in order to absorb additional capital. But this is far from uniform across the industry, with some managers saying they can invest only up to USD500m in a particular country, while others have no problem investing more than double that.

There is a shift in talent underway in Asia from the investment banks to the new hedge fund houses that are setting up. Despite a large pool of talent there, one difficulty in Japan is the tradition of loyalty toward employers, which makes it hard for people to announce that they are resigning to start a hedge fund. However, this problem is counterbalanced by moves on the part of increasing numbers of Japanese institutions to set up a hedge fund or strategy.

As the market matures, hopefully Asia will see a broadening of the range of hedge fund strategies. Established European and US managers coming into the region are bringing with them experience of different strategies, which is important for the Asian market because there is a real need for hedge funds to be able to diversify their investments. At the moment, you can count the number of credit arbitrage funds in the region on two hands. Greater variety would do much to attract important classes of investors such as funds of hedge funds.

Citco recognised these trends a couple of years ago, along with the need for more sophisticated service providers in the region, and has built the right skill set by transferring talents from outside the region to service the Asian market.

Theo Splinter is managing director of Citco Fund Services (Australia) in Sydney.

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