Brand Name Fund of Hedge Funds Seen Scrambling in Japan
"Your legacy should be that you made it better than it was when you got it."
Lee Iacocca, b. 1924, former chairman and CEO, Chrysler Corporation
The hedge fund of fund (HFoF) business in Japan is at a crossroads. Recent turbulance including the departure of the chief investment officer at the Ivy FoHF complex has again put the spotlight on the industry and the future buying/selling patterns of Japanese institutional investors.
The aforementioned firm had (according to a summer 2006 Bloomberg article) around US$2 billion in sales in Japan. This was after a steady stream of redemptions that many global "brand name" FoHFs experienced in 2005. At its peak the same firm probably had close to US$3.5 billion in Japanese client sales.
Other well known losers have been FRM and Grosvenor. The latter is believed to have suffered the steepest redemptions on the back of reportedly lack luster performance over an extended period. And there are almost certainly another half a dozen other names that have experienced substantial "asset bleed" in Japan.
So how has the FoHF business become so toxic? In the early 2000s, most local distribution partners were typically re-selling FoHF products to Japanese financial institutions. Those institutions were particularly anxious to goose up their portfolio returns and comprised what became known (negatively) as "hot-money" or "performance-chasers".
Aside from ongoing concerns and questions with regards to transparency it was an easy relationship in which the FoHF would split some portion of their fees with a local distribution partner (like a Japanese trust bank or broker) who in turn added a sales fee on top of everything else to the end investor in Japan. Think about that - fees on fees on fees on....
So how did many of these FoHF products actually perform? Many are secretive about their performance and do not often report to commercial data vendors. Somehow this is part of their marketing strategy maintain some kind of aura of exclusivity in the industry.
That said we have tried to understand what was going on. Using the HFR Fund of Funds Composite Index (Offshore): 2002 2.5%, 2003 11.08%, 2004 6.19%, 2005 7.73%. But if we add in likely distribution fees these numbers might have been reduced by another 2% each year to give 2002 0.5%, 2003 9.08%, 2004 4.19% and 2005 5.73%. Add to that recent up-ticks in the risk free rate and the opportunity cost of HFoF vs. other investments underwent a not so subtle change.
Interestingly, really big Japanese institutions report that they privately would pay only 70-75 bps in upfront management fees for HFoF product that was publically available at 1-1.5% per annum.
Also, when returns of HFoF was noticeably lagging some late-comers including a prominent west-coast name offered product to certain investors in Tokyo at a 80 bp fee all-in.
The result was that a trickle out of brand name HFoF manufacturers became a flood!
When Basel II regulation changes became a source of concern with its resulting impact on Japanese bank capital requirements in early 2005, doing business selling HFoF products ground to a halt. In fact product was dumped.
So balance sheet worries were compounded by an overall negative experience with these brand name FoHFs with regards to performance. Poor performance triggered redemptions among disgruntled pensions. Some of them turned to single managers and niche products (emerging markets), private equity, real estate and other structures like ABS/CDOs as well as going back to long-only investing opportunities.
In this period Japanese investors also started to question the whole FoHF fee model - fees on fees. "Why should I pay for my HFoF manager to fly business class around the world and stay in 5 star hotels, on top of everything else I pay him?" This was a common gripe among investors.
In other words, the investor started to flip back through their OMs to rationalize what exactly they were paying for. When performance is/was there this was overlooked. Not any more, and this too became an additional irritation.
All told, from 2005 between US$12-15 billion is likely to have been redeemed from the brand name FoHFs by Japanese institutional investors. And for some of them additional redemptions are likely to continue.
The HFoF model, their products, fees and how they are marketed need to evolve to the new reality. They must learn to Adapt or Die - especially those with significant exposure to Japanese institutional investors.
In fact, if I was an institutional investor in another region I would pay particular attention to the influence and weight of Japanese institutional money also invested in the FoHF product. Now might be a time to negotiate lower fees in return for "more sticky" assets. Mahalo.
"Your legacy should be that you made it better than it was when you got it."
Lee Iacocca, b. 1924, former chairman and CEO, Chrysler Corporation
The hedge fund of fund (HFoF) business in Japan is at a crossroads. Recent turbulance including the departure of the chief investment officer at the Ivy FoHF complex has again put the spotlight on the industry and the future buying/selling patterns of Japanese institutional investors.
The aforementioned firm had (according to a summer 2006 Bloomberg article) around US$2 billion in sales in Japan. This was after a steady stream of redemptions that many global "brand name" FoHFs experienced in 2005. At its peak the same firm probably had close to US$3.5 billion in Japanese client sales.
Other well known losers have been FRM and Grosvenor. The latter is believed to have suffered the steepest redemptions on the back of reportedly lack luster performance over an extended period. And there are almost certainly another half a dozen other names that have experienced substantial "asset bleed" in Japan.
So how has the FoHF business become so toxic? In the early 2000s, most local distribution partners were typically re-selling FoHF products to Japanese financial institutions. Those institutions were particularly anxious to goose up their portfolio returns and comprised what became known (negatively) as "hot-money" or "performance-chasers".
Aside from ongoing concerns and questions with regards to transparency it was an easy relationship in which the FoHF would split some portion of their fees with a local distribution partner (like a Japanese trust bank or broker) who in turn added a sales fee on top of everything else to the end investor in Japan. Think about that - fees on fees on fees on....
So how did many of these FoHF products actually perform? Many are secretive about their performance and do not often report to commercial data vendors. Somehow this is part of their marketing strategy maintain some kind of aura of exclusivity in the industry.
That said we have tried to understand what was going on. Using the HFR Fund of Funds Composite Index (Offshore): 2002 2.5%, 2003 11.08%, 2004 6.19%, 2005 7.73%. But if we add in likely distribution fees these numbers might have been reduced by another 2% each year to give 2002 0.5%, 2003 9.08%, 2004 4.19% and 2005 5.73%. Add to that recent up-ticks in the risk free rate and the opportunity cost of HFoF vs. other investments underwent a not so subtle change.
Interestingly, really big Japanese institutions report that they privately would pay only 70-75 bps in upfront management fees for HFoF product that was publically available at 1-1.5% per annum.
Also, when returns of HFoF was noticeably lagging some late-comers including a prominent west-coast name offered product to certain investors in Tokyo at a 80 bp fee all-in.
The result was that a trickle out of brand name HFoF manufacturers became a flood!
When Basel II regulation changes became a source of concern with its resulting impact on Japanese bank capital requirements in early 2005, doing business selling HFoF products ground to a halt. In fact product was dumped.
So balance sheet worries were compounded by an overall negative experience with these brand name FoHFs with regards to performance. Poor performance triggered redemptions among disgruntled pensions. Some of them turned to single managers and niche products (emerging markets), private equity, real estate and other structures like ABS/CDOs as well as going back to long-only investing opportunities.
In this period Japanese investors also started to question the whole FoHF fee model - fees on fees. "Why should I pay for my HFoF manager to fly business class around the world and stay in 5 star hotels, on top of everything else I pay him?" This was a common gripe among investors.
In other words, the investor started to flip back through their OMs to rationalize what exactly they were paying for. When performance is/was there this was overlooked. Not any more, and this too became an additional irritation.
All told, from 2005 between US$12-15 billion is likely to have been redeemed from the brand name FoHFs by Japanese institutional investors. And for some of them additional redemptions are likely to continue.
The HFoF model, their products, fees and how they are marketed need to evolve to the new reality. They must learn to Adapt or Die - especially those with significant exposure to Japanese institutional investors.
In fact, if I was an institutional investor in another region I would pay particular attention to the influence and weight of Japanese institutional money also invested in the FoHF product. Now might be a time to negotiate lower fees in return for "more sticky" assets. Mahalo.
posted by Franklin Scruggins | 11:24 AM
1 Comments:
All in all, the meat of the survey is pretty predictable, and for those who have been following Orange County equity investment environment - it should not be suprising. But more importantly, the survey does confirm that United States still needs to go a long way in developing its judicial system toward protection of rights as well as dealing with the tedious bureaucracy of doing business.
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