The total assets invested in hedge funds by Japanese investors at the end of 2002 is estimated to be around US$20.5 billion, which is slightly over 3% of the global investment in hedge funds.
Asset allocated in Hedge Funds by Japanese Investors
as of Dec 2002*
| Japanese Investor | @ December 2002 (US$bn) |
|---|---|
| Insurance Company | 8.5 |
| Banks | 5.0 |
| Pension Fund | 3.8 |
| Corporate | 1.0 |
| High Net Worth | 1.2 |
| Others | 1.0 |
| TOTAL | 20.5 |
| * by AIP-Tokyo 2003 |
* by AIP-Tokyo 2003
This asset size will hopefully grow in coming years; however the growth in 2003 is expected to be quite limited. It could even be negative.
This article attempts to provide some ideas on how to evaluate future opportunities in hedge fund investment in Japan by looking at the recent history in hedge fund investments by major Japanese institutional investors.
- Some Japanese major banks and trading companies started
hedge fund investments around 1996 and they could be considered
as the first generation hedge fund investors in Japan. Although
other major institutional investors, such as life insurance
companies, had started their studies on hedge fund investments
from early 1998, shocking news about LTCM and the collapse
of some fixed income arbitragers forced them to suspend or
give up such new investments.
- Not many institutional investors started on their hedge
fund investments during 1999 due to the superb performance
of Nikkei since the beginning of 1999. Furthermore their fears
as a result of the 1998 shock had not been fully alleviated.
- The big crush on IT shares in early 2000 in Europe, USA and
then in Japan, definitely offered an opportunity to Japanese
institutional investors, including Japanese Pension Funds,
to introduce hedge funds into their portfolios. They interviewed
managers, consultants and prime-brokers from mid to late 2000,
but most of them could only start investing in hedge funds
after April 2001 - the first month of the new fiscal year.
- As required in their due diligence process, most institutional
investors required a minimum of 3-year track records, which
would have included the strain of 1998. The investors could
not help but show major concerns over such big drawdowns.
Consequently most of them felt quite comfortable to start
with market neutral based or arbitrage based strategies which
had very little volatility in performance numbers, and they
preferred similar strategies for constructing or investing
in funds of funds. Some of them avoided directional trading,
such as global macro, managed futures, or higher volatility
strategy, such as emerging markets.
- After going through all the marketing materials and prospectuses
of managers, it did not take major institutional investors
long to get attracted to the good performance numbers generated
in 1999. Thanks to these numbers, it was quite natural to
expect 15%-20% annual returns for aggressive strategies, or
8%-12% for conservative ones from the very beginning of their
investments.
- Simultaneously hedge fund performance slackened due to lower
interest rates and poor performance in equity markets in Europe
and the US. But Japanese institutional investors who had just
participated in hedge fund investments in 2000 or 2001 as
a new comer were annoyed not by the flat performance but by
a big gap between their high expectations and the actual figures
reported by the managers.
- Things got from bad to worse in 2002. FoF performances in
2002 were generally flat in US$ terms. The final figures in
Japanese Yen after considering currency hedging cost was negative
for some FoFs. Once again, these figures disappointed the
institutional investors.
The following is a list for CSFB-Tremont Hedge Fund Index, S&P500 and Nikkei 225 from 1997 through 2002.
| 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | |
|---|---|---|---|---|---|---|
| S&P500 | 31.01% | 26.67% | 19.53% | -10.14% | -13.04% | -23.37% |
| Nikkei225 | -21.19% | -9.29% | 36.79% | -27.19% | -23.52% | -18.63% |
| CSFB-Tremont Hedge Fund Index | Convertible Arb. | 14.48% | -4.41% | 16.04% | 25.64% | 14.58% |
| Eqty-Mkt Neutral | 14.83% | 13.31% | 15.33% | 14.99% | 9.31% | 7.42% |
| Fixed Income Arb | 9.34% | -8.16% | 12.11% | 6.29% | 8.04% | 5.75% |
| Evnt Driv-Distrsd | 20.73% | -1.68% | 22.18% | 1.95% | 20.01% | -0.69% |
| Evnt Driv-Multi | 20.53% | -8.98% | 23.00% | 11.84% | 6.79% | 1.22% |
| Evnt Driv-Risk Arb. | 9.84% | 5.58% | 13.23% | 14.69% | 5.68% | -3.46% |
| Eqty-Long/Short | 21.46% | 17.18% | 47.23% | 2.08% | -3.65% | -1.60% |
| Emerging Mkt | 26.59% | -37.66% | 44.82% | -5.52% | 5.84% | 7.36% |
| Global Macro | 37.11% | -3.64% | 5.81% | 11.67% | 18.38% | 14.66% |
| Managed Futures | 3.12% | 20.64% | -4.69% | 4.24% | 1.90% | 18.33% |
- Having experienced such unfavourable situations, interest
in hedge fund investments in Japan seemed to taper off in
early 2003. Although some argued that the overall hedge
fund performance is still better than the Nikkei's, the
problem was largely the big gap between their high expected
returns and the actual numbers.
- Japanese banks and life insurance companies have had big
exposures to Japanese equities due to cross-holdings or
pure investments. The more Japanese equities continued to
fall, the less risk tolerant they were on their portfolios.
Consequently some of them were forced to liquidate the so-called
risky or riskier assets, such as hedge funds, in their portfolios.
They had taken up hedge fund investments because of the
ultra low interest rate and poor Nikkei performance in Japan.
Then they were forced to redeem or suspend such hedge fund
investments, which has been performing better than the Nikkei,
because they were less risk tolerant and the hedge fund
performance did not meet their expectations during the last
12-24 months.
- Japanese institutional investors are often very risk
cautious, and therefore they try to avoid investing in high
volatility strategies, such as emerging market, global macro
and managed futures. But these strategies, such as managed
futures, sometimes show exceptional performance, and this
would get the Japanese investors interested all of a sudden.
If they have a quick decision-making process, it could work.
But the reality is Japanese institutional investors generally
engage in a time-consuming decision-making process. The
problem they freqently face here is they may bump into a
next drawdown right after they have obtained an approval
and started an investment.
- For Japanese institutional investors with a long-term investment horizon, it should be a good idea to cover various strategies rather than concentrating on the so-called lower risk strategies. Diversification should be employed not only for risk control purposes, but to prepare for all weather conditions for the sake of profit taking.
