The 2007 edition of the Eurekahedge Asia and Japan Hedge Fund Directory contains information on over 1,1501Asian hedge funds2. Based on this and related information, we currently estimate the total size of the Asian hedge fund universe at US$132 billion as of end-2006, up 30% from our end-2005 estimate of US$101 billion. Judging by this, the performance of the Eurekahedge Asian Hedge Fund Index (+16% for 2006 and +12% annualised), and the general growth of the industry over the last decade (see Figure 1), the Asian hedge fund space continues to be on an exponential growth curve on both counts – number of funds and size of assets.
In this report, we attempt an in-depth analysis of the trends shaping the aforementioned growth. The write-up is structured into two main sections on the current structure of the industry and on fund performance. The former reviews several of the salient aspects of the Asian hedge fund space (such as age, size, investment style, etc) and how their interplay has impacted fund performance over the years. The latter section, on the other hand, takes a closer look at fund performance itself – at how Asian hedge funds fare against their peers in other regions, against other modes of alternative investment, and lastly in terms of the performance fees they charge.
Size and Age
In one key manifestation of the exponential growth seen in the Asian hedge fund universe, average fund size has grown by over 50% in the last five years, from US$80 million in 2001 to the current US$127 million. More specifically, while funds with under US$50 million in assets grew over seven-fold in terms of number of funds (refer to Figure 2), it is the growing number of funds with sizes between US$50 and 500 million that has helped shore up these averages. Indeed, it would be reasonable to assume that many of the smaller-sized funds of five years ago now populate the US$100 to 500 million size range.
On that note, we put together a grid of average fund performance during the last 12 months (ie performance for the year 2006), with age of the fund on the horizontal axis and size of the fund on the vertical (see Table 1).
Basically, the table gives a snapshot of average 2006 performance for a fund of a particular size and age. The rationale behind using 2006 performance as the comparative measure is that that was the only period of returns that all the funds surveyed would have in common. From an investor’s point of view, this table provides valuable insights about the relationship between fund size and performance. For one, funds tend to start small and grow big. The funds that do start big do their fund-raising on the strength of experienced fund managers; while they do generate superior returns, not all investors can have access to the same. Also, returns in bigger-sized funds tend to diminish during the initial few years of operation and the latter-stage revival in returns tends to be a case of diversified multi-strategy investments.
Assuming the case then of a, say, US$25 million fund that falls into the next bigger size range in each successive year of its operation, an individual investor into this fund can expect to double his/her investment in the first three years of the fund’s life, on average (with returns of 21%, 22% and 32% in the first three years, respectively). As returns wane in the fourth year, he or she could either repeat the process with another newly launched small-sized fund or adopt a different permutation from the table below.
Table 1: Comparative Performance by Age and Size of Asian Hedge Funds
Under 1 Year
Over 10 Years
Source : Eurekahedge
Strategy, Geographic Mandate and Manager Location
In this section, we review the current make-up of the Asian hedge fund industry in terms of investment strategy employed, region invested in or the country that a fund manager is based out of. Each of these choices shapes the nature of returns that a fund can expect to generate. For instance, previous research on Japan-investing hedge funds in the Eurekahedge databases uncovered an advantage to being located in Japan as opposed to, say, the United Kingdom. To that end, this section reviews the strategies, regions and locations that currently make up the Asian hedge fund space, and which of them have seen the most growth in recent years.
Also of interest is the way each of these variables interacts with the others in generating a particular type of returns. This is dealt with in the sub-section on ‘performance’ by comparing the regions and locations that proved the most profitable, on average, for a particular strategy over the last 12 months.
Over the year 2006, the distribution of assets among various strategies (Figure 3) has remained largely unchanged from 2005 figures, with assets in long/short and multi-strategy funds still making up for almost 75% of total industry assets. That said, the market shares of other strategies are also gradually growing, as is evident from the graph in Figure 6.
In terms of investment regions, however, the shares of funds with a broad Global mandate have slipped (as funds increasingly choose to focus on specific regions and/or economies), and so have those of Japan-focused funds (as the markets had a terrible run in 2006; the Eurekahedge Japan Hedge Fund Index returned a negative 3% for the year). On the flip side, Asia ex-Japan funds in general, and India- and China-focused funds in particular, grew in size.
Figure 3: Breakdown of Industry AuM by Strategy
Source : Eurekahedge
Figure 4: Breakdown of Industry AuM by Geography
Source : Eurekahedge
Figure 5: Top 10 Manager Locations for Asian Hedge Funds
Source : Eurekahedge
In terms of manager location too, there has been a shuffling of market shares. Switzerland and Norway are gaining ground over the UK as key European locations for Asia-focused managers. On the other hand, in Asia, Singapore and Hong Kong, poised to ride the booming markets in India and China, have managed to increase their market shares with respect to Japan and Australia.
Elaborating on the growth themes hinted at in the previous section, figures 6 and 7 chart the strategic and geographic constitution of the Asian hedge fund universe (by number of funds) respectively over the past three years.
As is evident from Figure 6, long/short equities, the dominant strategy among Asian hedge funds (making up the remainder of the 100% each year), has seen a steady decrease in the number of funds. Similar is the case with multi-strategy funds. On the other hand, arbitrage, event driven and fixed income funds have gradually increased in number. Similarly, in Figure 7, India- and China- focused funds were on the rise while the numbers of Japan-investing funds declined, over the past three years.
Figure 6: Change in Strategic Mix of Total Fund Population
Source : Eurekahedge
Figure 7: Change in Geographic Mix of Total Fund Population
Source : Eurekahedge
The broad growth trends seen in the previous two sections do not fully explain the actual 2006 performance of various Asian strategies investing in specific regions or based out of specific locations. These performance comparisons are flushed out in Tables 2 and 3 below.
Table 2: Comparative (2006) Performance by Strategy and Region of Asian Hedge Funds
Setting aside the usual suspects among the best-performing funds, ie funds investing in Greater China, India and emerging Asia in general, or funds located in China, Hong Kong, Singapore etc, these tables have other interesting themes to outline. For instance, while Japan-investing funds have turned in the worst returns for 2006 on average, Japan-investing CTAs and Japan-located macro and relative value funds were clearly in positive, not to mention healthy, territory. Likewise, Singapore-based funds exploring arbitrage opportunities in the Greater China markets posted the best returns in 2006 by a wide margin (84%). Among event-driven strategies, Hong Kong based funds (+56%) were in the best position to exploit emerging special situations in Asia ex-Japan in general (+49%) and Greater China in particular (+64%).
Table 3: Comparative (2006) Performance by Strategy and Manager Location of Asian Hedge Funds
This sets the tone for the peer group analysis in the following section, as we look at the average performance of Asian hedge funds over the last three years in comparison with other regional hedge funds on the one hand, and other modes of alternative investment in Asia on the other. This is followed by a concluding sub-section on how the comparative average returns for each of these alternative investments appear after factoring in the performance fee component.
Asia vs Rest of the World
Having examined the various endogenous factors affecting hedge fund returns in Asia, this section asks the next logical question of whether hedge fund investments in Asia are better than those in other regional markets in North America, Europe and Latin America.
To answer this question, we compared the average returns (risk-adjusted and otherwise) as well as the quartile dispersion of returns, for each of the regional hedge fund spaces3over the past 36 months. This is depicted graphically in Figure 8. The broad conclusion is that investments in Asian hedge funds are generally better than those in their developed market peers – an Asian hedge fund picked at random generates over 10% in returns 50% of the time, while the probability of similar returns from a randomly selected European or North American fund is roughly under 40%. Furthermore, the said Asian fund would offer comparable, if not better, risk-adjusted returns in both cases.
On the whole, however, the quality of returns is the highest in Latin American funds with not only mean returns at 15% but also a return-to-risk ratio of over three times. However, given the economic uncertainty surrounding recent political events in Latin America, we expect the demand for Asian hedge fund investments to continue at its current pace.
Figure 8: Mean and Quartile Returns across Regional Hedge Funds
Having established that Asian markets are, on average, conducive for superior hedge fund returns, it remains to be seen whether better returns can be sought from other modes of alternative investment in Asia. In other words, assuming ready investor access to all three modes of investment, is it the region or the way one invests in the region has a bearing on returns obtained?
To answer this question, we carried out a comparative analysis of average past 36 months’ returns similar to the one detailed in the previous section, among Asian hedge funds, Asian (long-only) absolute return funds, and Asian funds of funds4, as represented graphically in Figure 9.
Evaluated purely on absolute performance, long-only funds are the investment vehicle of choice in Asia, with mean returns at an impressive 17%. But on a risk-adjusted basis, Asian hedge funds prove to be marginally better. Furthermore, long-only funds benefited from largely bullish trends during the period under consideration.
Asian funds of funds too have their merits offering a much tighter spread of returns than the other two, and indeed better bottom-quartile returns than Asian hedge funds – an investor who invested into a randomly selected Asian fund of funds is ensured returns of 7% or more 75% of the time, whereas the probability of similar returns with a similarly selected Asian hedge fund is lesser.
Of course, in reality, the choice of investment vehicle boils down to their accessibility (especially the better-performing ones) to investors. This and the following section are merely exercises in testing whether, on average, hedge funds offer better quality of returns.
The Fee Element
To be sure, the returns compared in the previous section are net of fees. Hedge funds in the region charge an average incentive fee of 19.2%, while long-only funds and funds of funds charge 10.9% and 7.6% respectively5. On the face of it, among all fund managers, hedge fund managers retain the largest portion of the returns generated in the form of incentive fees. But this comparison does not account for the fact that funds of funds charge a second layer of fees on top of those charged by the underlying funds that they invest in.
In order to perform a more accurate comparison, we added back the average fee component to the average 36-month returns (annualised), for each fund type. In the case of Asian funds of funds, we added back to the cum-fee returns a second layer of fees (calculated as a combined average of the performance fees of long-only funds and hedge funds) to account for deductions made by the underlying fund managers. With the total cum-fee returns for each of the funds, and the respective shares that went to investors and fund managers, at hand, we calculated how a hypothetical return of US$100 would be distributed in the case of each fund type. The end-result is shown in Figure 10.
As can be seen, in the ultimate analysis, Asian hedge funds have in fact returned a bigger portion of the total returns to their investors than Asian funds of funds, leading us to conclude that Asian hedge fund investments continue to be attractive to investors.
In conclusion, our outlook for Asian hedge fund growth as well as performance in 2007 remains positive. This view is driven not only by the robust pace of industry growth seen during the last few years, but also by the fact that the dominant theme in the underlying financial markets now is one of a global boom in M&A (the year 2006 marked a total of US$3.6 trillion in acquisitions), and large and/or cash-rich private equity funds making inroads into heretofore unexplored markets, emerging or otherwise (Japan, for instance). This should provide ample opportunities for hedge funds allocating to opportunistic plays.
There is also the rising trend of local market debt in emerging markets. In the case of local corporate debt in emerging markets, most new issuers tend to be first-time borrowers. This leaves ample room for mis-pricing the debt owing to several factors such as lack of investor familiarity and/or lack of proper pricing mechanisms. Such mis-pricings also afford profitable long/short opportunities and facilitate the deepening of these markets.
This trend of broadening and deepening emerging markets, together with the combination of undervalued currencies, reasonable valuations and positive earnings growth, also support the positive outlook. China and India are cases in point, offering attractive investment avenues through an array of companies benefiting from the countries’ economic growth.