Union Bancaire Privée’s new ESG hedge fund targets Japan’s patchy corporate governance record

Zuhair Khan, UBP

A new hedge fund launched last month by Union Bancaire Privée which trades on good and bad governance within Japanese companies has started positively – and portfolio manager Zuhair Khan (pictured) says the country’s patchy record on board oversight will continue to offer strong investment opportunities.

The U-Access Long/Short Japan Corporate Governance Fund – which runs USD65 million in assets – is a market- and sector-neutral equity hedge fund that goes long and short using corporate governance as its key metric. 

The investment portfolio comprises 30 long positions and 60 short positions, selected according to how well or badly a company is run, out of an investment universe of 500 of the largest and most liquid Japanese stocks across all sectors and industries.

As interest in environmental, social and governance (ESG)-related investing has surged within the global hedge fund industry, Khan - a managing director and senior fund manager at UBP Investment - sees governance as the cornerstone of sustainable investing.

“It’s about having a high-quality board and management that will do the right thing for the right reasons,” he tells Hedgeweek. “If you have this in place, then over time that should generate good returns. But if you can’t trust the G – the governance of a company – then can you really believe what they say about the E or the S?” 

Early gains

The fund’s main dollar-denominated institutional share class has generated a 2.8 per cent gain since its 14 July launch, with volatility around 5 per cent, in line with expectations and despite challenging market conditions towards the end of last month.

Khan’s investment strategy is built around the idea that good corporate governance strengthens company performance in the long run, while poor governance leads to a lacklustre showing and, ultimately, investor aversion. 

Khan – who joined UBP’s Tokyo office last year from Jefferies, where he had been head of research for Japan focusing on corporate governance and shareholder activism – says his thesis is backed up by almost six years of continuous detailed analysis of the ways in which Japanese companies are managed. 

Khan began his research after market authorities in Tokyo adopted a Corporate Governance Code and Stewardship Code in 2015, following several years of attempts by regulators to overhaul corporate governance in the country.

“The Governance Code started to bring about a change where you began to see a transformation in a certain percentage of companies but, crucially, not all of them,” explains Khan, who prior to Jefferies had been a CIO and portfolio manager at boutique hedge funds running absolute return Japanese equity portfolios, following stints at UBS Global Asset Management and Bank of Tokyo-Mitsubishi.

“One of the interesting things I found is that most people see Japan as this very homogenous country where all the companies are the same. But there are three very distinct types of companies there, based on their governance.”

He says the first grouping – numbering about 20 per cent - are proactive in their attitudes towards governance, making genuine steps towards overhauling and improving their board structures. 

Secondly, about 50 per cent tend to be more reactive. These firms will do the minimum required under Corporate Governance Code, but with a 12- to 24-month lag, typically spurred on by the actions of their peers and competitors. 

“The remaining 30 per cent of companies are very obstructive,” Khan observes. “Five years into the Corporate Governance Code, and they’ve hardly changed at all. There may be some superficial changes but when you dig in a little bit you realise there’s no real substance to that change.”

‘Meaningful alpha’

With corporate governance improvements moving at markedly different speeds across different sub-sets of companies in Japan, Khan very quickly concluded that it was possible to run a long/short hedge fund strategy – using corporate governance as the primary stock selector - and generate what he describes as “meaningful alpha”.

Using proprietary data mined from his deep-dive research, prospective positions are scored on a range of metrics, including board structure – which encompasses shareholder alignment, the business experience and level of empowerment of its independent directors – along with things like shareholder structure, business fundamentals and valuations.

The long book is made up of well-run companies with strong balance sheets and fundamentals , while the fund takes short bets on firms with poor governance and weak fundamentals, and which are trading at either a premium or at levels which are not at a meaningful discount to their broader sector. 

“It’s not that we are looking for good governance companies and then we just use our shorts for hedging. Not at all - we actually generate a lot of alpha from the short side, and the alpha tends to be more consistent,” he explains.

“In Japan, getting governance right continues to be a problem,” he adds, acknowledging that governance is sometimes seen as a “somewhat fuzzy” concept in the country.  “It’s an ongoing effort of continuous improvement. So it’s almost easier to find more shorts than longs.”

Governance gaps

Cedric Le Berre, investment specialist for Japanese equities at UBP, says the fund has managed to capitalise on growing investor scrutiny of company oversight in the country.

He says: “The awareness of governance in Japan has been raised for a number of years now, it was echoing concerns that investors in Japan had.”

The fund launched following an extended pre-marketing phase in late 2019, attracting just under USD60 million of seed money, split between UBP private bank clients in the UK, Europe and Asia, as well as institutional clients in Japan.

“People are more keen to invest in hedge funds this year than in previous years,” Le Berre adds of the successful launch. 

With AUM now at around USD65 million, the portfolio has an equal target weighting of 3.33 per cent for all the long positions and an equal target weighting of 1.67 per cent for each of the short positions.

“It’s very dispersed, but broadly what we find is that sectors where companies are larger and more international tend to have better governance, and make for good long ideas. The sectors which tend to be more midcap than mega-cap tend to have poorer governance,” Khan says. “But the most important thing is still the dispersion of good and bad governance within each sector. It is much broader and greater than the dispersion of governance across sectors, so we don’t need to take sector risk in order to do this long/short strategy.”

Looking ahead, he says that 2020’s market gyrations brought about by the coronavirus pandemic have also strengthened the prevailing investment environment for the strategy.

“The market fell 30 per cent in February and March, but it has since recovered. In mid-July, when we launched, the market was flat. Then the yen started ticking up:  Japanese markets started to tank, down 5 per cent one week, then snapping back up 10 per cent over two weeks,” Khan observes. 

“This kind of volatility and dispersion in the market has ultimately created a lot of opportunities for us.”