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Long/short equity and macro strategy hedge funds offer investment opps in Asia, says Cambridge Associates

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Institutional investors performing due diligence on Asia-Pacific focused hedge funds may be best served homing in on long/short equity and macro strategies.

That's according to a recent report from Cambridge Associates, Investing in Asian Hedge Funds: Opportunities and Challenges, which notes that other strategies, like distressed credit and event-driven, may not pay off in Asian markets like they do elsewhere.
 
The report underscores the fact that investing in Asia-focused hedge funds requires a different framework than institutional investors typically use in other regions' markets.
 
"A hedge fund strategy that makes sense in Western European or American markets will not necessarily be applicable in Australia, China, or elsewhere in Asia," says Damien Tan, managing director and hedge fund specialist in Cambridge Associates' Singapore location.
 
"The reason institutional investors need a different perspective on hedge funds in Asia is the character of the markets. Despite the sophistication and diversity of opportunities in Asia-Pacific markets, they generally experience lower liquidity, higher market volatility, and different regulatory constraints than markets in Europe and the US.
 
"These differences, plus the limited number of managers, have significant implications for four prominent hedge fund strategies in an Asia Pacific context: long/short equity, macro, distressed credit, and event-driven.”
 
The report says the most promising strategies for Asia-focused hedge funds are:
 
• Long/short equity – Asia-focused hedge funds that employ a long/short equity strategy, which takes long positions in stocks expected to appreciate and short positions in stocks expected to decline, benefit from a large investible universe in Asia. The strategy also enjoys a smaller pool of professional managers relative to Western markets. Without the intense competition for ideas that dominates the Western markets, Asia-focused managers with robust investment processes and risk management have a larger pool of opportunities on which to draw, giving them greater potential to generate alpha, or excess return. In addition, there are more companies in Asian markets in which to invest than the combination of Western European and US exchanges. Asian long/short equity hedge funds do face some constraints, since good shorting access only exists in the developed markets of Australia, Hong Kong, and Japan, and market volatility makes fundamental stock picking in the region difficult. 

 
• Macro – Macro strategies, which bet on global macroeconomic developments with a broad array of instruments, may be one of the more compelling opportunity sets for hedge funds that focus on Asia. Asian markets present over ten distinct currencies for managers to trade, and they continue to emerge as economic powerhouses. But illiquidity does offer an added challenge for managers.

On the other hand, the strategies that present fewer opportunities for Asia-focused hedge funds are distressed credit and event-driven strategies, according to the report:
 
• Distressed credit – Some hedge fund managers in Asia focus on investments in distressed credit, or securitized bonds that are already in default or moving in that direction. However, most jurisdictions in Asia have limited enforceable creditor rights, making it difficult to invest effectively because of lower recovery values in credit default situations. Further, the strategy's opportunity set is not very robust; for example, China and Indonesia, which account for 71% of high-yield bonds in the Asia-Pacific ex Japan region, lack strong creditor protections. Also, Asian default rates for bonds are below global equivalents, leaving an even smaller opportunity set. If investing in distressed credit, investors might consider investing through a called capital fund structure, a vehicle that is more appropriately aligned with the relative lack of liquidity in the distressed credit markets in Asia. 

 
• Event-driven – Asia-focused hedge funds that seek to take advantage of mergers, restructuring, and other events that can result in the short-term mispricing of a company's stock also have a limited opportunity set. Such events are less common and smaller in magnitude in Asia than in other regions. For example, in 2013, the average deal size in Asia Pacific ex Japan was USD56 million, less than half the average deal size in North America (USD107 million). Additionally, in China specifically, many merger & acquisition transactions are between state-owned enterprises, usually resulting in lower spreads because of the transactional certainty.

 
"On a case-by-case basis, distressed credit and event-driven strategies can be attractive to explore; but time and resources are probably better spent researching long/short and macro," says Tan. "We do expect the general long-term potential of Asian hedge funds to grow even more promising as regulatory and legal frameworks continue to take shape."

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