Research

Hong Kong: A turning point for the number one Asian hedge fund hub

Hong Kong has been a major focal point within the Asia Pacific hedge fund industry, currently accounting for US$92.1 billion of assets under management (AUM), overseen by 449 hedge fund managers as of August 2019. Proximity to the fast-growing economy of China, availability of highly-trained talent base, as well as robust regulatory landscape have successfully attracted both foreign and domestic hedge fund managers to base their operations in the special administrative region. The Hong Kong hedge fund industry has continued to grow and reach new highs on the back of robust investor allocations and performance-driven growth in the post-GFC era. Seen as the gateway to China, Hong Kong is uniquely positioned to benefit from foreign asset owners interested in allocating into the Greater China region, as well as domestic asset owners looking to gain international exposure.

The Hong Kong hedge fund industry faced tough challenges in 2018, following the escalation of the US-China trade war which saw both sides levying tariffs on each other’s imported goods. The trade disruption induced by protectionist policies severely weighed on both Hong Kong and mainland China’s equity markets, and tilted the region’s growth outlook downward, which was compounded by the weakening Chinese yuan and China’s slowing economic growth. Total assets managed by Hong Kong-based hedge fund managers dipped by US$0.4 billion in 2018, and fund liquidations outpaced new launches throughout the year, resulting in a net decline of 24 funds in the industry population. The first quarter of 2019 saw equity markets recover from the sell-offs they suffered in Q4 2018 as dovish central bank policies and PBOC stimulus programs provided support for the underlying markets, yet the risk sentiment shifted quickly in the second quarter of the year, with the US-China trade tension suddenly re-escalating when the Trump administration announced additional tariffs on imported Chinese goods, which prompted the other side to respond in kind. Apart from the US-China tariff spat, Hong Kong’s stability as a financial centre came under scrutiny due to the ongoing protests and social unrest in reaction to the extradition bill proposed by the government in February 2019. The protests, which have continued for months have unnerved the markets for fear of capital outflows, eventually culminating in the downgrade of Hong Kong’s credit rating by major agencies. In spite of all the challenges the special administrative region has faced in recent months, total assets managed by Hong Kong-based fund managers grew by US$6.9 billion year-to-date – mostly driven by performance growth – resulting in a new high of US$92.1 billion. Risk sentiment on the region’s hedge fund industry for the remainder of the year may also benefit from the dovish stance adopted by major central banks, and anticipation over further easing from the PBOC.

Figure 1: Asset flows and AUM of the Hong Kong hedge fund industry
Asset flows and AUM of the Hong Kong hedge fund industry

Net investor redemptions from Hong Kong-based hedge funds totalled US$0.3 billion over the first three quarters of 2019 – the first negative net flows recorded by the industry since 2009. Small to medium-sized hedge funds overseeing up to US$500 million in assets bore the brunt of the investor outflows since the beginning of the year, in contrast to how their larger peers have continued to see positive allocations year-to-date.

The two figures below illustrate the population breakdown of Hong Kong-based hedge funds based on their investing strategies and regions. Long/short equities and multi-strategy are the most commonly adopted strategic mandates within the region, accounting for 59.1% and 10.3% of the industry population respectively. Looking at geographical mandates, just under a third of the hedge fund managers based in Hong Kong focus on the Greater China region. Global and Asia inc Japan mandates follow behind with 23.1% and 22.8% population shares respectively.

Figure 2a: Hong Kong hedge fund industry population breakdown by strategic mandate
Hong Kong hedge fund industry population breakdown by strategic mandate

Figure 2b: Hong Kong hedge fund industry population breakdown by geographic mandate
Hong Kong hedge fund industry population breakdown by geographic mandate

Figure 3 compares the performance of the Eurekahedge Hong Kong Hedge Fund Index – a custom index comprising 526 flagship hedge funds headquartered in Hong Kong – against the Eurekahedge Asian Hedge Fund Index and three composite indices representing the stock exchanges of Hong Kong, Shanghai and Shenzhen. Since the end of 2007, Hong Kong-based hedge funds have generated an annualised return of 5.28%, which compares against the 4.39% returned per annum by the average Asian hedge fund over the same period. The Shenzhen Composite Index has produced an annualised return of 0.75% since the end of 2007, while the Hang Seng Index and the Shanghai Composite Index are still under their respective high-water marks.

Figure 3: Hong Kong hedge fund performance since 2007
Hong Kong hedge fund performance since 2007

Table 1: Performance in numbers – Eurekahedge Hong Kong Hedge Fund Index against comparable benchmarks

Eurekahedge Hong Kong Hedge Fund Index

Hang Seng Index

Shanghai Composite Index

Shenzhen Composite Index

Eurekahedge Asian Hedge Fund Index

2008

(19.19%)

(48.27%)

(65.39%)

(61.76%)

(21.07%)

2009

31.07%

52.02%

79.98%

117.12%

26.92%

2010

9.91%

5.32%

(14.31%)

7.45%

9.31%

2011

(8.19%)

(19.97%)

(21.68%)

(32.86%)

(7.48%)

2012

10.59%

22.91%

3.17%

1.68%

9.67%

2013

17.09%

2.87%

(6.75%)

20.03%

15.28%

2014

5.80%

1.28%

52.87%

33.80%

7.04%

2015

5.76%

(7.16%)

9.41%

63.15%

6.94%

2016

(0.72%)

0.39%

(12.31%)

(14.72%)

0.46%

2017

22.83%

35.99%

6.56%

(3.54%)

17.26%

2018

(8.49%)

(13.61%)

(24.59%)

(33.25%)

(8.72%)

August 2019 year-to-date

5.51%

(0.47%)

15.73%

24.56%

4.72%

2-year annualised return

0.99%

(4.10%)

(7.33%)

(9.89%)

0.67%

2-year annualised volatility

7.18%

17.98%

16.81%

22.30%

5.97%

2-year Sharpe ratio (RFR = 2%)

(0.14)

(0.34)

(0.55)

(0.53)

(0.22)

3-year annualised return

5.72%

3.84%

(2.20%)

(8.07%)

3.85%

3-year annualised volatility

6.52%

15.91%

14.86%

19.61%

5.22%

3-year Sharpe ratio (RFR = 2%)

0.57

0.12

(0.28)

(0.51)

0.36

5-year annualised return

4.88%

0.78%

5.42%

5.43%

4.23%

5-year annualised volatility

7.97%

17.77%

24.65%

31.48%

6.05%

5-year Sharpe ratio (RFR = 2%)

0.36

(0.07)

0.14

0.11

0.37

Source: Eurekahedge

The table above provides the key risk-return statistics of the five indices exhibited in Figure 3 above. Key takeaways include:

  1. The Eurekahedge Hong Kong Hedge Fund Index has returned 5.51% as of August 2019 year-to-date, proving their resilience against the pressure exerted by the ongoing protests and political concerns over the recent months. The Hang Seng Index was down 0.47% over the first eight months of the year.
  2. Hedge fund managers headquartered in Hong Kong suffered their worst annual losses post-crisis in 2018, with the Eurekahedge Hong Kong Hedge Fund Index down 8.49% for the year. The aggressive Fed rate hikes and trade tension between China and the US weighed on equity markets around the globe, especially those in the Greater China region – as shown by the double-digit declines recorded by the three equity market indices in the table above.
  3. Over the last five years, Hong Kong hedge fund managers have returned 4.88% per annum, outperforming the average Asian hedge fund which has returned 4.23% per annum over the same period. However, in terms of risk-adjusted performance, Asian hedge fund managers outperformed their Hong Kong-based peers by virtue of their lower volatilities.

Table 2: Correlation matrix
Hong Kong Hedge Fund Strategy Profile Correlation Matrix

Table 2 above illustrates the correlation coefficient between the returns of Hong Kong-based hedge fund managers against comparable benchmarks. The Eurekahedge Hong Kong Hedge Fund Index exhibited high correlation against the Eurekahedge Asian Hedge Fund Index and the Hang Seng Index: 0.97 correlation coefficient against the former, and 0.86 against the latter.

Figure 4 below provides the 12-month rolling alpha generated by Hong Kong hedge funds against the three equity market benchmark indices since the end of 2008. It could be observed from the figure that the hedge fund managers headquartered in Hong Kong have generally been able to generate positive alpha for the majority of the time.

Figure 4: 12-month rolling alpha of the Eurekahedge Hong Kong Hedge Fund Index against comparable benchmarks
12-month rolling alpha of the Eurekahedge Hong Kong Hedge Fund Index against comparable benchmarks

Over the longer period from the end of 2007, the Eurekahedge Hong Kong Hedge Fund Index has generated positive alpha against the three equity market indices: 0.41% against the Hang Seng Index, 0.49% against the Shanghai Composite Index, and 0.38% against the Shenzhen Composite Index.

Even though the Hong Kong hedge fund industry has managed to withstand the pressure exerted by the global trade tensions, we have yet to fully see how the ongoing social unrest will impact the special administrative region’s asset management landscape. The increasingly volatile situation could subvert the region’s image of stability and robustness which has hitherto attracted asset owners and talented fund managers, but for the moment though Hong Kong’s hedge fund industry continues to remain resilient.

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