The End of Japan Long/Short Equity?
"When a person with experience meets a person with money, the person with experience will get the money. And the person with money will get some experience."
Leonard Lauder
In Asia, October mid-month 2006 returns look shaky for Japan Long/Short Equity managers. 25 out of 40 hedge funds reporting to a well-known Swiss bank posted negative returns, while on a YTD basis 32 out of 40 remain very much "under-water"( i.e. drowning). And just how much underwater is a worry as the most popular names are an average of -10% to -25% down.
This is all the more surprising as for most of these high class, experienced players, CY2005 returns came in an average of 15% to 30% on the positive side. As many other researchers (like MS, or Morgan Stanley) have noted, private clients chase returns and this is apparently what happened in terms of net asset flows to Japan over the early part of this year.
That is one big investor "black eye" - whether you are a Swiss institutional investor, family office, Japanese pension or US university endowment. The way that institutional investors view Japan, relative to their other portfolio geographies and opportunities for the remainder of 2006 will be critical in deciding whether we see the beginnings of a net outflow of fund flows heading into 2007. Those decisions are being tabled as I write.
How did so many strong hedge-fund winners now collectively be losers is one of the real questions as yet to be studied and explained by the industry. Simply choppy markets, bad calls, a sudden loss in liquidity, the implosion of small caps, enduring market scandals, bad luck, no trend (meaning uptrend)...these are all of the excuses suddenly seeping out of the mouths of many of these Japan Long/Short managers.
So their old tricks suddenly don't work and there are no hot IPOs to goose monthly returns especially through the end of the quarter. Take a look at gross and net exposure levels and try to understand where performance was generated in 2005 vs. 2006. This must be all too worrying for the average investor in Geneva, Zurich, New York, Chicago or Hong Kong. What happened, what is happening and is it a fundamental shift in how Japan Long/Short Equity is being executed by these practicioners? Of equal interest is the oddity that many of these managers are down about the same amount? And, what about the "hedge" that most of them promised? Were these players ever really hedged or merely levered long?
Finding the underlying reasons IS important. And it is incumbant on an investor to do his/her research and to feel comfortable with it. Why? Because not too long ago Asia (including Japan) was deemed the long-awaited investment opportunity, one to ride out through the Beijing Olympics in 2008 regardless of whatever happens on the Korean penninsula. There were plenty of 15%-20% performers there...and the market is liquid, making it slightly better than other emerging markets.
Many global hedge fund managers have themselves invested resources outside of the U.S. opening and staffing offices in Singapore, Hong Kong, Sydney and Hawaii to be part of what was expected to be a runaway freight-train to Performance Nirvana. They had not done so since the Asian Crisis of 1998. They have even devoted increasing amounts of capital to non-U.S. investment opportunities and in some cases they have incoporated Asia-related strategies and funds into their global operations.
The worry for these hedge funds is now very serious. Aside from taking more inter-month telephone calls and emails from investors (which they typically despise) about what is going on with Japan, the CEOs of these firms will now face the stark reality that as EoY (end of year)performance bonuses are calculated there will be little to nothing to hand out. Like the orphan child in a Dickinsian novel there might not even be a lump of coal.
And without equity in the business, you can expect quite a lot of disappointment, dissatisfication and dissilussionment within their employee ranks. Expect the best performing individuals whether in the front and back offices of some of these big players to move on to greener pastures. Moreover, the freshly minted MBAs armed with expectations of call-option type earning ability, might be "forced-back" into the investment banking ranks for financial security. The cracks might already be appearing.
As investors, one should have to monitor closely the remuneration of "key" individuals to assess such brain-drain flight risk. As investors you whould want to see the most valuable employees get well-paid. Investors should also go back and re-read the fine print of their fund documentation to find out when they can get out of their respective hedge fund losers, and at what cost! Those decisions are coming. Trust me, Japan Long/Short Equity is no longer a sure thing if you think you can get 15% net of fees with low risk.
There is also talk that some institutional investors are looking to modify their investment philosophy from investing purely for absolute return (which doesn't make sense if you are down 20%) to one in which you focus on modified high-water marks and relative benchmarks.
Expect investors to switch investments into cheaper, beta-chasing benchmarks such as ETFs that reflect more on the upside. The result might not be a continued asset growth in Japan/Asian hedge fund markets at a 20-30% CAGR but rather a tailing-off with investors focusing on revised environment in which Long/Short Equity hedge funds have grown more correlated to the markets; where investors become more fee conscious and take that into their investment decision; and, where for some pension/institutional managers more focused quantitative specialists gain AUM (assets under management) such as the State Streets, GSAMs and BGIs, and other enterprising Japan Equity Market Neutral managers can expect to make a killing if their product produces alpha and is scalable.
There is another dimension too. What about the myriad of Asian and Japan-focused fund of hedge funds, numbering well over 100 globally. Armed with their glossy marketing docs that boasted uncorrelated performance and great returns a couple of years ago, they too have been bloodied. Returns are generally down. These players can expect to lose AUM very soon, as most of them have made fundamental flaws in portfolio construction that has not accounted quickly enough to the spectre of rapid correlation among so-called different managers.
Rather than thinking "big-big" (investing in big hedge fund names) there is probably more diversification going "small-big", that it a selection of small managers mixed with big ones chasing different deals and arbitage opportunities. Moreover, a prominent hedge fund manager and former colleague of Soros once said: everyone knows that the first 4 years of a manager's exisitence is his most profitable. That is the time when he needs capital and ironically it is the time he will not goet it from institutional investors. Of course, this implies another set of different risks for the investor. Chances are they are still likely to be better than the 2006 Japan Long/Short Equity benchmark of being down 15-20%!
Consider the well-known Japanese broker who set up a Japan Long/Short Equity fund of funds product a couple of years ago. There were approx. 8-10 different managers. Unfortunately, the correlations of those products have probably converged . The portfolio was built at a time when the long side of virtually every Japan portfolio was heading upwards. Hedge funds were uncorrelated de rigeur.
Today, that portfolio is almost surely flat on its face, especially among the firm's senior management who put down approximatley US$50 million to seed it while it built up a track record. Its outside investors are probably pulling back their commitments as they have done with many of the firm's other sponsored hedge fund products. Earlier this year perhaps sensing the pressure its chief strategist moved on to another firm. So, the wheels keep on turning but the question still remains for investors and managers: what is to become of Japan Long/Short Equity? Quite a lot I think.
Maholo.
"When a person with experience meets a person with money, the person with experience will get the money. And the person with money will get some experience."
Leonard Lauder
In Asia, October mid-month 2006 returns look shaky for Japan Long/Short Equity managers. 25 out of 40 hedge funds reporting to a well-known Swiss bank posted negative returns, while on a YTD basis 32 out of 40 remain very much "under-water"( i.e. drowning). And just how much underwater is a worry as the most popular names are an average of -10% to -25% down.
This is all the more surprising as for most of these high class, experienced players, CY2005 returns came in an average of 15% to 30% on the positive side. As many other researchers (like MS, or Morgan Stanley) have noted, private clients chase returns and this is apparently what happened in terms of net asset flows to Japan over the early part of this year.
That is one big investor "black eye" - whether you are a Swiss institutional investor, family office, Japanese pension or US university endowment. The way that institutional investors view Japan, relative to their other portfolio geographies and opportunities for the remainder of 2006 will be critical in deciding whether we see the beginnings of a net outflow of fund flows heading into 2007. Those decisions are being tabled as I write.
How did so many strong hedge-fund winners now collectively be losers is one of the real questions as yet to be studied and explained by the industry. Simply choppy markets, bad calls, a sudden loss in liquidity, the implosion of small caps, enduring market scandals, bad luck, no trend (meaning uptrend)...these are all of the excuses suddenly seeping out of the mouths of many of these Japan Long/Short managers.
So their old tricks suddenly don't work and there are no hot IPOs to goose monthly returns especially through the end of the quarter. Take a look at gross and net exposure levels and try to understand where performance was generated in 2005 vs. 2006. This must be all too worrying for the average investor in Geneva, Zurich, New York, Chicago or Hong Kong. What happened, what is happening and is it a fundamental shift in how Japan Long/Short Equity is being executed by these practicioners? Of equal interest is the oddity that many of these managers are down about the same amount? And, what about the "hedge" that most of them promised? Were these players ever really hedged or merely levered long?
Finding the underlying reasons IS important. And it is incumbant on an investor to do his/her research and to feel comfortable with it. Why? Because not too long ago Asia (including Japan) was deemed the long-awaited investment opportunity, one to ride out through the Beijing Olympics in 2008 regardless of whatever happens on the Korean penninsula. There were plenty of 15%-20% performers there...and the market is liquid, making it slightly better than other emerging markets.
Many global hedge fund managers have themselves invested resources outside of the U.S. opening and staffing offices in Singapore, Hong Kong, Sydney and Hawaii to be part of what was expected to be a runaway freight-train to Performance Nirvana. They had not done so since the Asian Crisis of 1998. They have even devoted increasing amounts of capital to non-U.S. investment opportunities and in some cases they have incoporated Asia-related strategies and funds into their global operations.
The worry for these hedge funds is now very serious. Aside from taking more inter-month telephone calls and emails from investors (which they typically despise) about what is going on with Japan, the CEOs of these firms will now face the stark reality that as EoY (end of year)performance bonuses are calculated there will be little to nothing to hand out. Like the orphan child in a Dickinsian novel there might not even be a lump of coal.
And without equity in the business, you can expect quite a lot of disappointment, dissatisfication and dissilussionment within their employee ranks. Expect the best performing individuals whether in the front and back offices of some of these big players to move on to greener pastures. Moreover, the freshly minted MBAs armed with expectations of call-option type earning ability, might be "forced-back" into the investment banking ranks for financial security. The cracks might already be appearing.
As investors, one should have to monitor closely the remuneration of "key" individuals to assess such brain-drain flight risk. As investors you whould want to see the most valuable employees get well-paid. Investors should also go back and re-read the fine print of their fund documentation to find out when they can get out of their respective hedge fund losers, and at what cost! Those decisions are coming. Trust me, Japan Long/Short Equity is no longer a sure thing if you think you can get 15% net of fees with low risk.
There is also talk that some institutional investors are looking to modify their investment philosophy from investing purely for absolute return (which doesn't make sense if you are down 20%) to one in which you focus on modified high-water marks and relative benchmarks.
Expect investors to switch investments into cheaper, beta-chasing benchmarks such as ETFs that reflect more on the upside. The result might not be a continued asset growth in Japan/Asian hedge fund markets at a 20-30% CAGR but rather a tailing-off with investors focusing on revised environment in which Long/Short Equity hedge funds have grown more correlated to the markets; where investors become more fee conscious and take that into their investment decision; and, where for some pension/institutional managers more focused quantitative specialists gain AUM (assets under management) such as the State Streets, GSAMs and BGIs, and other enterprising Japan Equity Market Neutral managers can expect to make a killing if their product produces alpha and is scalable.
There is another dimension too. What about the myriad of Asian and Japan-focused fund of hedge funds, numbering well over 100 globally. Armed with their glossy marketing docs that boasted uncorrelated performance and great returns a couple of years ago, they too have been bloodied. Returns are generally down. These players can expect to lose AUM very soon, as most of them have made fundamental flaws in portfolio construction that has not accounted quickly enough to the spectre of rapid correlation among so-called different managers.
Rather than thinking "big-big" (investing in big hedge fund names) there is probably more diversification going "small-big", that it a selection of small managers mixed with big ones chasing different deals and arbitage opportunities. Moreover, a prominent hedge fund manager and former colleague of Soros once said: everyone knows that the first 4 years of a manager's exisitence is his most profitable. That is the time when he needs capital and ironically it is the time he will not goet it from institutional investors. Of course, this implies another set of different risks for the investor. Chances are they are still likely to be better than the 2006 Japan Long/Short Equity benchmark of being down 15-20%!
Consider the well-known Japanese broker who set up a Japan Long/Short Equity fund of funds product a couple of years ago. There were approx. 8-10 different managers. Unfortunately, the correlations of those products have probably converged . The portfolio was built at a time when the long side of virtually every Japan portfolio was heading upwards. Hedge funds were uncorrelated de rigeur.
Today, that portfolio is almost surely flat on its face, especially among the firm's senior management who put down approximatley US$50 million to seed it while it built up a track record. Its outside investors are probably pulling back their commitments as they have done with many of the firm's other sponsored hedge fund products. Earlier this year perhaps sensing the pressure its chief strategist moved on to another firm. So, the wheels keep on turning but the question still remains for investors and managers: what is to become of Japan Long/Short Equity? Quite a lot I think.
Maholo.
posted by Franklin Scruggins | 7:33 AM
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