Asia's core attraction to global allocators is that there are some world class managers who typically still have capacity.
Allocating to a hedge fund manager is the result of a search for talent allied with capacity, and this is no different in Asia. But global allocators looking to managers in Asia will find some different characteristics, some driven by the youth of the industry, some by the nature of the underlying capital markets, and some cultural.
Intention of this article
This article provides an overview of the industry in Asia, primarily for the benefit of potential allocators. While I have tried to include hard data, publishing schedules and a very rapidly developing industry mean that the numbers will inevitably be out of date by the time you read this; qualitative comment is of far more commercial value. I have therefore tried to provide as much qualitative colour to the picture as possible, and have emphasized the commercially useful over the statistically perfect wherever possible.
Information is attributed wherever appropriate. Otherwise, opinions and observations are my own and not necessarily those of AIMA or of GFIA Pte Ltd.
Global allocators are beginning to review the universe of hedge fund managers in Asia more seriously, and are beginning to allocate capital to take advantage of quality managers, even as some of the more directional capital leaves the region.
The fastest growing source of new members for the Alternative Investment Management Association (AIMA, the industry body for the hedge fund industry) is Asia, with currently 21% of global membership in the region.
A recent survey suggested that global allocators currently had of the order of 2.5% of their assets in Asian strategies, their intention in aggregate is to increase this over a six-month period by 44% . Even if the actual rate of growth does not match that intention, there is no doubt that Asia is rapidly becoming an inescapable part of the hedge fund world.
According to EurekaHedge, a Singapore-based specialist hedge fund broker, there are 290 Asian hedge funds, including Japan and Australia.
If we slice this to include only funds with US$50m or more under management and at least a 12-month history, we arrive at a universe of 53 funds. Looking at the numbers slightly differently, AsiaHedge, the industry journal for the Asian hedge fund industry, estimates that 35% of management groups have less than US$50m of assets under management.
Research conducted by GFIA, an independent researcher of Asian hedge funds, suggests that there are some smaller and newer funds that, qualitatively, deserve serious attention (sometimes because they are spawned by an already stable organization), and that the universe of funds that might pass an initial screen by a fiduciary investor would approach 100.
Applying a rough and ready 80:20 rule to these numbers, we could assume that about 20 would at any one time be appropriate for serious consideration. While this is a small absolute number, it's probably about the same ratio of total funds to quality candidates as the hedge fund universe in either the U.S.A. or Europe, and it's certainly a large enough universe to keep an analyst busy full-time. However the geographic dispersion (see chart) of the managers' location means that, although first-level screening can arguably be done anywhere in the world, qualitative due diligence, including building trust and confidence with a manager, can be tough for allocators without a physical presence in the region.
When I first started researching Asian hedge funds in 1998, a common complaint was that, with no more than one or two exceptions, they were mostly go-go mutual funds with a performance fee. While I don't think that was ever a totally fair criticism, it's true that the universe was initially dominated by fundamentally driven, long-biased, directional long-short equity managers. Some of the early Asian hedge funds were unashamedly chasing the highest returns possible from equity implementation of macro-type thematic bets.
source EurekaHedge April 03 1
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. But within the catch-all category of equity long-short, there are single-country, sector-specific, model-driven, trading, and other niche strategies, as well of course huge divergence of manager style.
Intuitively, managers based in the region should have better access to information and therefore better performance, but there's no hard research to suggest this is the case. There are some powerful Asian strategies run from London, New York, and other locations ex-Asia.
The manager breakdown by location broadly is as follows:
Japan has some large managers, aided by the (relative) liquidity of the stockmarket and availability of stock borrow. Given that the restructuring of Japan is being emphasized at the micro level (even if by default due to the lack of restructuring at the macro level), unsurprisingly equity l/s is the dominant strategy. Most Japan managers have a dual office structure, with an onshore and an offshore base, driven by tax considerations - many in fact have no, or a token presence, onshore, with London, Singapore and Sydney being popular locations. There is some fund of funds presence in Tokyo.
Hong Kong has a substantial industry, aided by the relative depth of the conventional money management industry there. The majority of Hong Kong funds are therefore equity long-short, with a smaller number of successful fixed income and relative value players. There are a couple of global funds of funds with local presence, and at least 4 indigenous fund of fund groups.
Singapore has a newer and relatively small industry (although numbers of managers are on a par with Hong Kong), but is demonstrating a couple of niches in Japan strategies, and relative value and other non-equity strategies (driven by the number of banks that have proprietary trading centred in Singapore, as a key source of management talent). A small number of global funds of funds have some representation in the Republic.
Australia has a vibrant hedge fund industry, stimulated significantly by the growing tendency of local institutions to make allocations to alternatives. Many managers are however very small, but the top half a dozen are receiving meaningful allocations from global managers. Strategies represented are an eclectic mix, including domestic, regional, and Japanese strategies.
The Asian capital markets still limit options for event-driven managers, stat arb traders, and pure market neutral players, though there are examples of all these types within the industry. However, in the search for talent and capacity, there's enough here to keep the global allocator interested.
Appetite for capital
In 2002, 66 new hedge funds started in Asia, raising an aggregate US$1.7bn . That's an increase of over 30% in the number of funds, with an average of US$25m per launch (tho' the median would be significantly lower than this). The picture for 2003, as I write, looks broadly similar. Subjectively it feels as if the typical quality of start-up is improving, partly as the footprints of those have gone before help newcomers avoid mistakes, and partly as financial institutions are now shedding real muscle into the marketplace, with star professionals looking for second careers.
source EurekaHedge April 03 2
From the chart above, you can see that the typical Asian hedge fund is still a small business. 70% of Asian hedge funds have less than US$50m under management (although the same may be substantially true for the US industry). Asiahedge calculate that the 5 largest funds in the region control 28% of the assets, tho' that concentration has been weakening recently as the industry deepens.
Doing some quick'n'dirty math, the majority of Asian managers probably generate less than US$1m/year in revenues, for a business that needs at minimum two or three highly experienced financial professionals, and usually must service an international client base. A third of funds have less than US$10m under management - and of these, half have been in business for over a year, and still have less than US$10m of assets. That's a great deal of personal commitment for the managers running those strategies.
Even in the US and Europe, many start-ups struggle to achieve critical mass. But in Asia even managers who bring significant credibility to a new operation can find it difficult to achieve scale quickly.
There are several reasons for this.
First, the industry is young. Fewer than 100 funds have been running for more than three years (and only 40 or so for more than five years) and therefore the supply of "graduates" carrying with them a track record and reputation from existing firms, is limited. Asia isn't a conventional "lifestyle" destination for professionals leaving careers in the U.S. and Europe to resettle, so apart from a few hedonists in Singapore and Sydney, few experienced professionals choose to relocate to Asia from elsewhere. So talent typically is new to the hedge fund industry, usually from long-only asset management houses, or proprietary trading, with the learning curves widely associated with those career paths, and resulting hesitation on the part of allocators. One of the implications for an allocator is that the organization needs to show a good learning feedback loop - often an excellent manager will produce the best returns after 12-18 months running a hedge fund, when he's learnt the hardest lessons, and allocators need to be sensitive to where in the learning cycle the manager is.
Secondly, many allocators are unfamiliar with the capital markets in Asia, and therefore are less comfortable with strategies in this playground. The nature of the markets here has some implications for the industry, too.
This is unsurprisingly a short section. Most Asian hedge funds, while they may have an onshore advisor conforming to local regulations, offer offshore and largely unregulated product. Furthermore, to date, most Asian allocators and investors have preferred to invest in such structures. A long discussion of regulations would be fruitless, with the exception of some comment about the appearance of regulated retail-oriented products, which are feasible, though arguably not that important yet, in several jurisdictions.
The industry in Asia typically offers Cayman structures, US LLPs, and separate accounts, and global allocators face few regulatory hurdles. In most cases, allocators need only confirm as part of their organizational due diligence process that the onshore management company is appropriately regulated and licensed - their counterparty risk will be with a type of structure with which they are very familiar.
Some managers in some jurisdictions (Australia, Japan) offer domestic funds for local investors who find offshore structures difficult for tax or other reasons.
Australia, Hong Kong, Japan, and Singapore all allow retail offerings of hedged product. The requirements in each jurisdiction differ, and as always the commercial realities of distribution and demand will dictate whether a manager wishes to offer product to local retail markets and whether therefore the cost of a domestic structure is warranted. To date only Japan has seen really significant demand, with Australia making some headway. In Hong Kong and Singapore retail demand has been slow to appear.
Characteristics specific to Asian strategies
"Asia" is not a single market. Depending on their strategy, managers may focus on one single market, a small handful of the friendliest, or 14 different markets (the number of markets included in the widely used MSCI indices). Geographically, remember that after your 13 hour flight from London (or, may Allah help you, your epic multi-hop trek from Chicago, losing a day of your life in the process) to Singapore, the geographic centre of the region, you still have a 7 hour flight to Tokyo or Seoul, a 4 hour flight to Hong Kong, a 5 hour flight to Shanghai, and a 7 hour flight to Sydney. Although almost all financial professionals speak English, you'll have to negotiate taxi drivers speaking in a host of languages you don't understand, and a different currency in each country. And best not to forget whether you should be thinking of Christian, Buddhist, Hindu, Muslim, or a host of other country-specific holidays (Respect for the Aged Day… International Women's Working Day…. Picnic Day….etc.!) when you're planning your itinerary.
All the Asian markets have different characteristics, in terms of the sectors represented, trading patterns, liquidity, and, importantly, availability, cost, and convenience of stock borrow. This of course creates arbitrage and diversification opportunities, but the dictum that "in a bear market the only thing that goes up is correlation" is as true of public equity in the region as any other asset class globally.
Compared with developed markets, there is less corporate activity in public markets (and therefore few event-driven strategies), but a resilient and sustainable supply of distressed paper; typically thin fixed income markets but from high quality issuers, a fairly highly quality supply of CB paper; some large but very inefficient derivatives markets, etc. The opportunity set is coloured differently in Asia.
Liquidity is a rapidly moving target, meaning that accurate hedging is often either difficult or expensive, or both - market neutral is at best a target, not a measurable result, in Asia. Gap risk can be high, and the clever arbitrage strategies have a habit of exhibiting nasty tails from time to time. Allocators can expect higher returns to compensate for these risks.
To ensure a supply of consistently profitable trades, a large proportion of managers are multi-strategy in fact if not in name. This can be difficult for allocators who both prefer a clear definition, or use quantitative optimization models that work best with clean strategies. Moreover, allocators need to differentiate between style drift, and perfectly legitimate changes in capital allocation within a fund. This is partly because Asia is (is always?) in transition and that's also true of its capital markets. What might be a red light elsewhere in the world may be pragmatic in Asia. One of the better Japan long/short equity managers, for example, says "I'd much prefer to do my research, find my Microsoft, and run it for several market cycles, and when it's right to do that, I will - but over the last few years market conditions have dictated that I trade". And he does, sometimes moving net long to net short and back within a month - and by doing so has annualized over 10% a year since inception three years ago. Will I still back him when he finds his Microsoft, despite the dramatic strategy shift this will entail? In principle, yes, as his strategy will very much follow his deep understanding of the market structure, which is what he's paid for.
Asian shops are, broadly, split into those run by western, or western-minded, managers, and indigenous, local managers. Cultural differences can be overstated - at the end of the day, capitalism is capitalism. However I'd make a couple of comments (necessarily general - remember, Asia is not homogenous). First, in most Asian countries, going independent is considered a one-way street, with no way back into "conventional" employment. That's an extra disincentive (and, conversely, an extra badge of courage) for Asian managers to set up. A number of really good managers in the region don't have the cultured polish of the Manhattan or Mayfair crowd, and although a good allocator will see through the polish or lack of it, it's a hindrance to rapid growth. Finally, many Asian business people have a culture of control, both of people and of cash. Many indigenous firms are characterized by a hierarchy that feels odd to an allocator used to looking at a more collegiate organization - and many are frankly under-resourced in terms of numbers and caliber of support (and sometimes investment) staff, in the interests of cash conservation. I spend a great deal more of my time than my peers elsewhere in the world looking at organizational risk - it's a key defining success factor in allocating to Asian hedge funds.
An advantage, however, is the very real manager diversification between indigenous and foreign managers. One of the very good Japan long/short managers I track, owned and managed by local professionals, typically has negative or very low correlations with its foreigner-operated peer group that cover a similar universe of stocks in superficially very similar strategies. The demonstrable quantitative difference is explained definitively by very cultural, qualitative differences in the mindset of the professionals in the business.
But allocators do need to spend more time on their Asian managers, and this, with the double whammy of distance (awkward time zones, long flights, and infrequent face to face contact) slows the rate of investment.
The silver lining, and this is a big one, is that most Asian managers have capacity. Although we're beginning to see some strains amongst the better known Japanese specialists, there remain several world class pure Japan managers with capacity. In Asia ex-Japan space, less than a handful of managers are closed.
A typical equity long/short manager in Japan would have capacity of perhaps US$500m, and in Asia ex-Japan, maybe US$200m (although under current conditions, both these figures may be lower). There are more than 60 Japan long-short funds that have assets of less than US$500m (of which, from experience, at least 30 would warrant some interest from a fiduciary investor); in Asia ex-Japan, 56 funds have less than US$200m, and the same empirical screen yields another 30 or so of interest to the professional investor .
Adding all this up, GFIA estimates that currently the good managers in the region still have an aggregate capacity somewhere between US$5bn and US$9bn. Given that liquidity has been imploding and we may be at a cyclical low in market capacity, this capacity is likely to increase. In terms of sourcing good capacity, allocators focusing exclusively on the U.S. and Europe are missing a large part of the potential universe.
So allocators that are prepared to do the work, have a window of opportunity to find high quality talent, in strategies that may well have little correlation to their existing holdings - and actually find that the manager is happy to take their money.
A final implication of the lack of capital in Asia is that, generally, information flows are good, as managers realize they must be flexible to woo investors.
A specialist Asian fund of funds I worked with obtained ongoing full position disclosure from all but one of the equity managers in its portfolio. I switched capital from a US-based fund to a very similar strategy based in Hong Kong (with similar quant characteristics but about half the capital) purely because the information flow from the midtown-mafia manager was always late, thin, and inflexible, while the Asian manager was happy to provide virtually any information I needed, immediately. This is an extreme example but not untypical.
Asian appetite for hedged product
Across the region, the major private banks have been active for many years selling hedged product - largely funds of funds - to wealthy families and individuals. Over the last two to three years this product push has reached down to the priority banking level, so the middle class professional with a few hundred thousand dollars in the bank has typically already been exposed to hedged, and in particular, fund of fund product. As always with the private banking industry, hard numbers are not available but sales are reported to be substantial. This is may partially explain why retail response to funds of funds has been weak - much of the demand has been satisfied already.
Some funds of funds groups (MAN group, Charles Schmitt in Hong Kong, Quadriga, etc) have packaged their products successfully to appeal to a wider spectrum of distribution such as IFAs and stockbrokers.
While demand from private banking clients across the region appears broadly homogenous, at the institutional and fiduciary investor level, the region exhibits diverse characteristics.
Japan accounts for approximately 10% of global demand for funds of hedge funds , and much of this has been from long term investing institutions such as life assurance companies (this group alone is estimated to have invested US$9bn ) and banks (US$4.5bn ) Many of Japan's institutional investors have been exposed to the industry since the early to mid '90s and are now among the world's more sophisticated allocators.
Hong Kong has a number of sophisticated family offices who are very familiar with hedged assets. At least two major fiduciary investing institutions have made allocations to hedge funds, advised by traditional asset consultants as part of a formalized portfolio construction process; in this respect, Hong Kong resembles other institutional markets in Europe and elsewhere. Although the total assets are not large, there is a depth of understanding of hedge fund allocation skills in the territory.
Demand from Singaporean institutions is currently muted though this is changing and two major public sector institutions are taking the asset class seriously. Reported forthcoming changes in the legislation controlling trustee investments may accelerate allocations.
Australian superannuation funds have been quietly making allocations for 2-3 years now, and it is estimated that perhaps a couple of dozen have now some exposure, either through a portfolio of single manager funds or funds of hedge funds. There appears to be at best moderate interest from family offices.
Other Asian markets such as Taiwan and South Korea are making inroads. South Korea in particular looks interesting as at least two major institutional investors have made allocations - in a largely homogenous environment, visible trendsetters can prove a powerful catalyst.
One of the themes evident in the Asian hedge fund industry is how the "alpha from beta" seekers are being replaced by more mainstream allocators. The international money in Asian hedge funds has often been attracted by the Asian growth story. Some managers (in particular some of those located outside the region) have built good businesses riding the waves, but hedge funds are not the best way to ride a liquidity driven bull market. During 2002, and continuing into 2003, there was a gradual erosion of holdings by "Asiaphile" investors, replaced with allocations from large global allocators who were less impressed with the Asia story than with the simple fact of managers doing the right job, with available capacity. While the number of these allocators is currently small (around 15-20 houses appear to have credible research awareness of the region, including such names as Credit Agricole, Deutsche Bank, Fauchier Partners, Investor Select Advisors, Parker Global Strategies, Union Bancaire Privee, and others), both the number of managers on the radar screen, and the number of allocators interested, appear to be growing.
Despite the second half of last year being treacherous as markets were buffeted by global events and, especially in Japan, domestic distortions, managers made money. The ABN Amro EurekaHedge index returned a creditable 6.3% in 2002, and has annualized at about 7.8% since the index' inception in January 2000. Asian equity remains very cheap, and credit strong. Few managers are currently using their balance sheets aggressively. Some of the arbitrage strategies are finding life difficult as hedging is increasingly expensive, and illiquid markets accentuate gap risk. The consistent performers currently, include distressed debt strategies (where continued supply suggests returns may be sustainable), and fixed income, where a dearth of players ensure consistent opportunities. The better traders are doing well, and in Japan, although capacity appears to be at a nadir, the micro restructuring argument supporting allocations to long/short strategies remains as strong as ever.
A number of managers are reshaping their strategies in reaction to recent market conditions. Some are widening their universe (Japan managers beginning to add Korea, for example). Some are emphasizing trading, as I've discussed. Many new start-ups are focusing on non-equity sectors of the capital markets.
I can see no reason why the number of managers in the region should not continue to grow at a net 25% per year or more. As the capital markets industries reshape, increasing numbers of competent managers will seek to build independent businesses.
Aggregate capacity is unlikely to be a problem for another 12-24 months, though we are beginning to see the cream of Asian managers move to soft closing, with one or two hard closed.
Increasingly global allocators will have to include Asia in their universe - not to do so would mean excluding an increasingly meaningful slice of the global opportunity set.
In summary, it's the inefficiencies in Asian capital and information markets which are creating good returns. Investors should expect both returns and volatilities to be higher, strategy by strategy, in Asia than in a developed market. However the universe of Asian managers is less and less directional, and increasingly able to capture returns from a wider range of opportunity sets.
Principal, GFIA Pte Ltd
AIMA Council Member, Singapore
This author would like to thank Paul Storey, editor of AsiaHedge, for his comments, suggestions, and contribution to the scope of this article, and EurekaHedge for access to their database.
1Source: Deutsche Bank “Alternative Investment Survey, 2003
2source: Bank of Bermuda
all these figures are sourced from Eurekahedge's database
3Source: Barra Consulting 2001. The author believes that although Barra's absolute numbers will have changed significantly in the intervening 2 years, the ratio cited is probably relatively stable.
4Source: AIP Tokyo estimate, September 2002