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Asian hedge funds become a more viable business

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While some specialists, and a few global names, have had exposure to Asian hedge funds for 10 years or more, in 2003 global allocators began to review the universe of hedge fund managers in Asia mo

While some specialists, and a few global names, have had exposure to Asian hedge funds for 10 years or more, in 2003 global allocators began to review the universe of hedge fund managers in Asia more seriously. The following year mainstream hedge fund allocators began to allocate capital to take advantage of quality managers, even as some of the more directional capital that arrived in 2003 left the region. In addition, we saw the establishment of dedicated sources of seed capital targeting Asian start-ups. Through 2005, those flows continued, though allocators became more discerning, and inflows concentrated in fewer managers. Another trend has been the increase in proprietary and fiduciary allocators, relative to funds of hedge funds and other intermediaries. In 2006, many substantial allocators put in place explicit strategies to allow them to understand and allocate to the Asian industry.

Last year and into 2007, many more allocators established their own research presence in the region. The trend to allocating a greater proportion of overall capital to a smaller number of managers continued.

According to Asiahedge, there are 760 Asian hedge funds, with aggregate assets of USD130bn (GFIA uses Asiahedge, Eurekahedge, and data for aggregate information; since databases are unlikely to be comprehensive, one should gross up numbers of managers and assets by between 5 and 10 per cent accordingly).  Allowing for managers that don’t report to databases, or who report but don’t report asset sizes, this probably suggests a total industry of about 900 Asia-dedicated funds, and perhaps USD200bn of assets. This is a substantial subset – at least 10 per cent – of the global industry.

We estimate that during 2006, at least 100 new Asian hedge funds were launched, continuing a fairly consistent 25 per cent rate of growth in the number of funds over the nine years that we have been following this universe. Looking at the pipeline for 2007, we expect that this rate of growth will continue,
and perhaps slightly accelerate, through this year. We expect that by 2008 there will be well over 1,000 Asian strategies available. From an allocator’s perspective, not only does Asia account for a meaningful part of the global industry’s assets, its rate of growth also makes it a core source of new capacity.

All the regional centres are expanding their manager base, while growth in the traditional home of Asian hedge funds, London, is slowing. There are an increasing number of cross-border propositions, such as Singapore managers dedicated to investing in India or Japan, as the global nature of the industry
arbitrages regulatory and operational differences.

We are also seeing many global hedge funds establishing a physical presence in the region to take advantage of investment opportunities. The apparent fall in Japan’s importance is misleading – it’s skewed by the tendency of Japanese managers to establish their management company elsewhere. Comparing our research schedule in 2006, compared with 2003, gives a qualitative indication of the changing relevant importance of the various jurisdictions:

  2003 2006
Delhi 0 1
Hong Kong 8 10
London 3 2
Melbourne 3 1
Mumbai 0 3
New York 1 1
Shanghai 0 2
Singapore* continuous continuous
Sydney 4 2
Tokyo 3 4

*GFIA is based in Singapore

We believe that in the near future the major geographic trends will include London and the US continuing to lose market share as the empirical evidence of better returns from indigenous managers becomes clearer. This is likely to be a gradual trend, since the lifestyle attractions of the major western centres remain strong.

The ratio of managers between Hong Kong and Singapore will remain broadly constant, though at the margin Singapore appears to be growing slightly quicker. We expect to continue to see managers investing in jurisdictions such as India, Japan and Korea that discourage boutique fund management companies to have a local presence, but the management company elsewhere. Singapore is currently a key beneficiary of this trend.

At the margin there will be continued fragmentation, with managers establishing a presence in Asian centres including Bangkok, Beijing, New Delhi, Kuala Lumpur, Melbourne, Shanghai and Taipei. Australia may become more important again. After an initial wave of manager formation in 2000-02, the availability of
domestic distribution and capital meant that a relatively small subset of managers was of interest to global allocators. As the industry develops, we see signs that this may change. There’s a new wave of manager formation in Japan. Driven substantially by an awareness of the very fundamental changes in corporate Japan and the associated capital markets, and manned largely now by Japanese nationals, the new managers provide a very interesting, if sometimes not yet polished, opportunity set.

There’s still a predominance of equity long/short managers, and the majority of those are still broadly Jones-model managers, who may do best in sideways or rising markets. Within the catch-all category of equity long/short, there are single-country, sector-specific, model-driven, trading and other niche strategies, as well as huge divergence in manager style, and all shades of directionality from extremely aggressive to beta-neutral to net short.

There’s also been growth in CTA-type, fixed income, multi-strategy and relative value managers. ‘Alternative alternative’ strategies packaged as hedge funds have also increased, including real estate, commodities, factoring, and environmental themes. More funds are participating in instruments such as PIPEs and private CBs, many of which appear to be channelled from the investment banks explicitly to the hedge fund community.

We’re seeing an increasing number of former traders either establishing funds or otherwise becoming involved in the hedge fund industry, which is continuing to reduce the dominance of directional equity long/short. Also, the emergence of multistrategy funds reflects the ample variety of trading opportunities in Asian markets that can be better exploited under a multistrategy mandate (as well as the need to scale the hedge fund industry – a multistrategy fund can accept more capital).
Lo oking at the pipeline of managers we talk to, we believe there’ll be a mini-rebirth of the absolute return non-benchmarked equity manager. This was the core of the Asian boutique industry 10 years ago, but an allocator looking for non-benchmarked longonly direction in Asia now has little choice outside some very large well-known names. Intuitively, managers based in the region should have better access to information and, therefore, better performance. Our research, and that of other authorities, indicates that at the aggregate level, this is indisputably the case. However there are some powerful Asian strategies run from London, which remains the home of the largest group of managers, New York and other locations outside Asia.

The typical Asian hedge fund is steadily becoming a much more viable business. Only about 48 per cent of Asian hedge funds have less than USD50m under management, compared with more than 60 per cent three years ago, and this proportion is stabilising.

Over the four years to mid-2006, the proportion of Asian hedge funds managing more than USD100m actually decreased slightly, from 19 per cent to 14 per cent (although as usual take the absolute values with a large pinch of salt), while the number in the USD10m-USD50m band increased from 32 per cent to 46 per cent. The industry is beginning to concentrate.

Nearly half all Asian hedge funds have been running for more than three years, and almost 200 for more than five years; the supply of ‘graduates’ carrying with them a track record and reputation from existing hedge fund firms is growing. At least a third of new managers we see are now driven by second or third generation professionals. Stimulating growth is increasing activity from the prime broking industry in Asia, with most of the big names now competing aggressively to encourage new managers, sometimes with client service staff in more than one Asian location, and the availability of many sources of seed or incubation capital, often from global investors.

The capacity picture of Asia is beginning to resemble that of the rest of the world, with popular managers soft-closing within 12 months, and a good track record virtually ensuring a close within 24 to 36 months. This is exacerbated by the smaller volume of underlying capital markets in Asia that constrains managers to smaller asset sizes. Only 9 per cent of Asian funds have more than USD500m in assets, and although this is changing (in 2004, only 5 per cent of Asian funds had more than USD500m of assets), to our knowledge fewer than half of those are accepting new capital. A typical equity long/short manager in Japan would have capacity of perhaps USD500m, and in Asia ex-Japan maybe USD250m. Our research suggests that the performance ‘sweet spot’ for an Asian long/short fund is around USD300m.

Liquidity has been increasing, but underlying capacity is rising more slowly due to constraints on shorting availability, the number of market participants. There are more than 100 Japan long/short funds that have assets of less than USD500m; in Asia ex-Japan, 37 long/short equity funds have less than USD200m.  We estimate that currently the better managers in the region still have an aggregate capacity somewhere in excess of USD15bn – and this has not, despite capital inflows, changed much in the last 24 months.

The ABN Amro Eurekahedge Index (as it then was) returned a creditable 4.71 per cent in 2002, but then a much more headlineworthy 26.05 per cent in 2003. The equivalent index returned 9.86 per cent in 2004, and 7.96 per cent in 2005. In 2006, the index had a return of 12.9 per cent including Japan, and a powerful 25.2 per cent excluding Japan. We believe that the capital markets and underlying economies of the region will continue to develop and create attractive returns for Asian hedge funds. 

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