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Hedge Funds in Asia

Monday, December 31, 2007

The Asian Hedge Fund Industry: Top Ten 2008 Forecasts

"If thou art pained by any external thing, it is not this that disturbs thee, but thy own judgment about it. And it is in thy power to wipe out this judgment now."

Marcus Aurelius,
Roman Emperor (161-180 AD)


Here goes for this author's first and only take on big, broad themes and what to make of Asia's hedge fund industry heading throughout 2008. It goes without saying that it will be a challenging time for the prime brokerages of major investment banks (GS and MS take note) as competition intensifies.

Number Ten. Asia' s SWF (Sovereign Wealth Funds) take the global stage. This has already started involving China and Singapore. One might even see them taking stakes in global hedge funds or hedge fund of fund firms. Who would have thought that after the Asian Crisis (less than 10 years ago) that they are now regarded as the "white knights of Asia" and potential savors of poorly managed U.S. investment banks!

One wild conjecture I will make is that a US$10 billion hedge fund firm might also succumb to an Asian SWF strategic ownership. For instance, why shouldn't GIC/Temasek become the single biggest investor in a fund like Tudor or Caxton (not that they will...but why not)?

Number Nine. Asia Multi-Strategy Finally Wins Supporters. This year has seen a select few do very well across a number of markets and countries. For example, Artradis out of Singapore has been a notable performance winner after a period in which AUM stalled together with performance. Expect more of the same from other fund firms such as DKR Oasis or PMA. The trick is finding homes for all those billion of dollars to invest!

Number Eight. Asia ex Japan Overtakes Japan. This is no real surprise given the almost 24 months of "sickly" returns of Japan equity markets versus those of its neighbors. Expect more and more Japan Long/Short Equity managers to fall victim to "geographic drift" using Japan as a core market short position. This has been a successful strategy for may firms which might include Joho and Penta to name a couple. It is a classic value trap for all evangelists who say that Japan is "cheap". Wait till the yen strength take hold again. It will get even cheaper.

Number Seven. The Rise of the Asian Institutional Investor. It is about time that insurance companies in Taiwan and Korea stepped up to the proverbial "investment plate" and allocated to private equity and hedge fund of funds. Once this starts expect a number of other country institutional investors to follow from Malaysia, Indonesia, Thailand and even Vietnam.

This will be the year for the marketing departments of U.S. and European hedge fund of funds to step up hiring of "experts" who have contacts and good reputations to start to nurture the process. It is about to begin so get ready. We estimate that Japanese institutional investors in hedge funds amounted (in the good old days) to US$75 billion with about US$40 billion comprising the rest of Asia. This balance will soon change and fast!

Number Six. While Japan Financial Firms Stagnate, Pension Demand Grows. No real surprises here. The real issue is where will Japan's financial firm capital go - back into the falling yields of U.S. Treasuries???? How about real estate or infrastructure projects in Asia? They are not going to be willing CDO buyers as they were in 2005 and 2006.

Number Five. Pan Asian Long Short Equity Grows. Asia is still estimated to be a high growth region for AUM growth and numbers of managers (albeit small). For example, we estimate that Asia hedge fund and # funds were US$140 billion and 700 in 2006 and by the end of 2007 this had grown to US$170 billion and 850 firms. If one includes all hedge fund assets (including from global funds and across all strategies) then AUM in Asia might even hit the US$300 bln mark in 2008.

One consequence of this is that brokers that make their money on the turnover of Japanese equities can expect business to continue to shrink in 2008; more than the 15-20% declines that they are likely to have seen in 2007!

Number Four. Singapore Challenges Hong Kong and Sydney as Asia's Hedge Fund Center. This is inevitable as MAS and others in Singapore have taken a hands-on approach to regulation (little as possible) and taxation (little as possible) to encourage fund formation and activity (as much as possible). For example, once they get really active in the seeding business this should make Singapore an even clearer location choice for fledging and growing hedge fund firms. Or will it? I look for the Singapore-based exchange to expand and buy up regional exchanges, especially in China and related to raw materials - after all there is a boom in those prices going on right now.

Number Three. Real Estate and Infrastructure Emerge as Hedge Fund Strategies. This is a positive theme that symbolizes the Globalization of the Consumer, especially in Asia. Look for countries like India and Vietnam to get on this bandwagon very fast. They already have...

Number Two. Retail Hedge Fund Strategies Emerge in Asia in Scale Courtesy of Traditional Hedge Fund Firms. I expect big firms like BGI, State Street and others to first attack the institutional market with so-called equity market neutral products (or quant funds). This is already happening and the big investors will allocate more, especially if downside risk to the region's equity markets continues to be a factor. China is the obvious next target for these firms.


Number One. Location! Location! Location! Someone will soon come up with a clearer idea as to what motivates the regions' managers choosing one place rather than another to set up shop.

In the same vein, long/short equity managers will also spend more time explaining their country allocation methodology to investors as a critical component of their regional alpha generation.

Finally, as Asian corporations from China to India become more acquisitive on the world stage there may actually be more hedge fund managers established in London and the New York/West Coast areas as emigres from these centers take a greater interest in their own markets.

As ever, as long as demand exceeds supply of available float these markets will continue to suffer typical EM growth pains involving spasms of high returns and steep losses. Moreover, as these countries get "richer" they will become increasingly important as sources of high-growth institutional investors. There is still a whole lot of beta to get out of the region.

Last but not least, China will win a record number of gold medals (over 110) at the Beijing Olympics... Mahalo.

Tuesday, December 18, 2007

Japanese Pensions Expect Less From Hedge Funds

"If you do anything just for money you don't succeed."

Barry Hearn, snooker promoter

According to a recent Russell Alternative Investment Survey on Japan, pension funds there account for just over 9% of total allocations. Further, Japanese investors expect hedge funds to return only 4.6% on average through fiscal year 2009. This is significantly lower than the roughly 9% annual return forecast by institutions in North America, Europe and Australia.

While the discrepancy in anticipated returns is indeed curious, it certainly opens the door for a number of hedge fund of fund operators that look to close the current 2007 calendar year with returns running in the 10-12% on annualized volatility of around 6%. The coming year should be a slam dunk for sales, no? Mahalo.

Monday, December 17, 2007

The 2007 Japan Story: Financial Investors Flee and Japan Managers Bleed

"We shall not perish as a people even if we get our money supply wrong - but if we get our human relationships wrong, we shall destroy ourselves."

Rt. Reverend Robert Runcie, b.1921
then Archbishop of Canterbury

A disappointing end to 2007 looks intact for Japan and the hedge fund industry.

First, the aftermath of financial institution's newly defined attitude to Basel II led to an estimated US$8-12 billion in redemptions by Japanese investors from hedge fund of funds and single managers. These are this author's conservative estimates.

Second, the performance of hedge fund managers with a Japan long/short equity focus have been almost (universally) pathetic. For instance, an early December 2007 HSBC report of hedge fund manager performance had 5 out of the bottom 20 listed as being Japan Long/Short Equity managers. On an equal weighted basis, average performance was MINUS 16.47%. In contrast, 4 out of the top 20 performing funds were Asia (excl. Japan) Long/Short Equity managers with an equal weighted performance of POSITIVE 70.09%.

This means that Japan is undergoing a double-whammy of poor fundamentals reflecting a negative outlook on Japan Inc. added to which a potentially negative technical institutional outlook in which financial institutions continue to search for alpha - but in ways that do not draw on additional capital requirements on their collective balance sheets.

Japanese business and the financial authorities are no doubt nervous heading into 2008. The exchanges must also be wringing their hands at the drop off in activity too.

Clearly, further changes are needed to make investing in Japan's industrial base more attractive (tax, legal and administratively related). They need to make life easier too for hedge funds - whether setting up onshore or even "helping" to promote greater efficiency in the system and not the opposite with regards to legislation helping poison pill defenses against so-called activist fund managers.

Ironically, a great way to take advantage of this situation would be for foreign hedge funds to short Japanese hedge funds, including one of the best known, Sparx. With the outlook for sales likely to stagnate given disappointing returns from their flagship Japan Long/Short Equity Fund, one might reasonably expect some shorting activity on the JASDAQ-listed equity.

Luckily on the investor side the picture is not totally glum. Anecdotal evidence suggests that hedge fund product is still in demand from pension plans in Japan, whether private or public. The authorities would be wise to speed up the debate to "when" and "how" to get into these strategies very soon in order to revitalize a situation that stands to ossify much like Japan's aging population issue which remains conveniently hidden in some distant cupboard. The time for action in now, or the hedge fund industry in Japan will slip to second place in Asia. Ironically, you might even see the GS conference eventually head offshore to HK or Singapore. Mahalo.

Sunday, December 09, 2007

Top Asian Hedge Fund Manager Hard Closes

"Everything comes to him who hustles while he waits."

Thomas A. Edison

John Zwanstra's firm, whose Penta hedge fund firm, tipped the AUM scales as at the end of October 2007 at a staggering US$4.8 billion is about to hard close. Interestingly this veteran who made his name a number of years ago trading Japan essentially worked out (along with Joho) that relying on Japan alone would not be sufficient as a reliable alpha source looking forward. The result - Zwanstra opted to broaden the geographical investment focus to include other countries in Asia.

Today, Zwanstra manages 3 hedge funds in addition to managed accounts. Penta Asia Ltd. (the offshore vehicle which was originally called the Penta Japan Long/Short Fund Ltd.) comprises US$2.2 billion while the Penta Asia Domestic Partners LP (the onshore vehicle) comprises US$1.0 billion; and finally, what he describes as his "market neutral" strategy called Penta Asia Long/Short Ltd. which manages US$1.2 billion.

Zwanstra has made a name for himself by navigating volatile markets and producing volatile returns. His recent positive success has been jaw dropping and certainly vaults him into this author's personal Hedge Fund League of Asia's Super-Producers. If one counts the time when Zwanstra's Penta was more Japan (small-cap focused) on a net-of-fee basis his returns by year for the Penta Asia Fund Ltd has been as follows: 1998, 15.80%; 1999, 153.76%; 2000, -48.25%; 2001, 1.35%; 2002, 3.58%; 2003, 109.99%; 2004, 2.73%; 2005, -18.78%; 2006, 185.32%; and, so far on a calendar year basis through 2007 (Oct end) 122.87%. Not bad at all!

Posting numbers like these in 2007 has been possible by tiliting the portfolio very heavily towards Hong Kong and Chinese stocks on the long side (approximately 75% of the long book) and holding a majority of shorts in Japan (35% of the short book).

Another interesting insight into the super-normal profits generated has been the fact that on the long side the bigget exposure has come from exposure to the real estate sector. This may be through equities and most probably through real estate hard assets. This reflects a growing global hedge fund trend. In the case of China, the real estate market continues to be on fire driven by excessive liquidity in the financial system. A perfect case in point has been Macau.

It comes as no surprise that in early 2008 Zwanstra plans to hard close the fund to investors. That is good news for existing investors. Presumably he is generateing a nice living in fees and not really interested in building out a larger, bank-like firm a la Ken Griffin's Citadel.

Other hedge fund managers in the region - especially those with a currently exclusive Japan-equity focus would be wise to take a leaf out of the Penta book and consider a broader geographical focus where alpha seems to be more available. That would seem to be a logical answer to the disappointing alpha performance in the land of the rising sun. Mahalo.

Wednesday, December 05, 2007

No Surprise! Japanese Pensions Still Want Hedge Funds

"The best leaders are apt to be found among those executives who have a strong component of unorthodoxy in their characters. Instead of resisting innovation, they symbolize it - and companies cannot grow without innovation."

David Ogilvy, b.1911
founder, Ogilvy and Mather

A recent Greenwich survey of361 Japan pension funds turned out to be one big yawn. Released with apparent fanfare (courtesy of the F.T.) it was notable in what it didn't say to the world regarding the status of hedge funds and the whole plethora of alternative investments.

If only so-called experts would clarify what exactly they are talking about!

First, we are apparently blinded by meaningless data related to financial institutions. The last time I looked, pension plans did not fall into that universe. We are informed that F.I.s have raised their overall allocations to alternatives from 63% in 2006 to 70% in 2007. We are informed that hedge fund allocations have decreased from an average of just under 5% in 2006 to 3.1% (of total assets) in 2007.

Sadly, it should be pretty plain to the international community (unless you have been living in a hole the last 3 years) that Japanese financial institutions, and specifically bank and bank-like institutions, have been subject to more stringent BIS regulations that have impacted negatively their willingness to take on more hedge fund product due to their higher capital requirements.

Another reality and side-effect of this was that many of these same institutions were the same ones that piled into high-yielding CDOs and sub-prime related structures as a way to goose their returns. We are now finding how deep they were involved in this mess.

The same cannot be said for Japan's pension funds which do not have short time horizons and certainly are not so concerned with mark-to-market valuations.

Back to Japan's pension funds. The US$1.068 trillion assets that the 6,000 pension funds manage in Japan have actually been bulking up on HFoF and single managers over the last 3 years - and in big amounts. This has taken place at the same time as a shake-out in FoHF "brand name" market shares (losers being Ivy and FRM) due to disappointing performance. On the traditional side their collective portfolios have been taken a whack from continued depression in the domestic stock market in addition to a declining US $ hitting U.S. denominated assets namely equities and U.S. Treasuries.

Today, hedge funds have penetrated into about 75% of Japan's pension market versus 65% in 2006. That makes it about 4,500 pension plans. The types of investment and the scale of their investments is better understood if one examines the alternative survey that was put together by Daiwa Pension Consulting not too long ago (and covered in a previous blog here).

Interestingly, this had already flagged the fact that pensions had been aggressive buyers of CDO and other structured products (yikes) in addition to being big buyers of private equity whether in "fast" economies like India or China or even in the U.S. It also pointed out that continued demand for private equity remains quite strong.

The Greenwich survey should have focused on how distribution channels have become far more competititive in the way product is sent into the pension market. It is no longer only the sole "property" of consultants and trust companies but now includes banking intermediaries too who are trying to loosen up the market offering white-label managed accounts and other vehicles that address the institutional demand for transparency. The other side of this is that many of the investors are still very interested in high octane products be they macro, commodity, managed-futures related or focusing on the "fast growth economies".

This author believes that the amount of Japan pension fund exposure to hedge fund products is likely to be understated in the Greenwich figures. First, their survey is skewed to the biggest pension plan in Japan. However, as a Columbia University study in this area 2 years ago stated, unlike in the U.S. and Europe, in Japan the smaller the pension plan the higher their allocations to hedge funds. The reverse is true in the U.S.

Second, as long ago as 2004/05 many pension had portfolio exposure running at around 8-11% of total AUM with some of the most "advanced" having up to 30% of their AUM in hedge fund assets. Admittedly there was a lot of "catch-up" that went on simply to make up for their overall portfolio poor performance that had been a feature of pension investing over the last 5 years.

Perhaps the biggest take-away in the Greenwich findings is something that has been apparent in the U.S. - that institutional investors are making decisions now regarding their "core" equity holdings. Like in the U.S. there is the clear problem in Japan among pension plans that their U.S. equities and U.S. fixed income has lagged in performance terms relative to international.

In Japan the issue is more marked as the Nikkei 225 Index or other equity index benchmark have pretty much sucked wind or been negative over the last few years. Meanwhile, the JGB market have remained at extremely low yielding levels for almost a generation! As a result, Japanese institutional investors have abandoned their own equity markets putting more moeny abroad and into the JGB market. This posture is evident in Tokyo Stock Exchange data that points to a dwindling % of market capitalization since 2003 of domestic institutions including banks, trust companies and lifers.

So the real question should be "what is the methodology that a pension plan should adopt to deploy assets related to their "core" equity allocation?" Also, what is the role of active absolute return strategies. THIS is the REAL challenge and opportunity facing hedge funds, fund of hedge funds and the investment community at large. It is not simply selling their products into a channel in Japan. Getting that figured out will be the real surprise for pension funds as well as hedge fund marketers. Mahalo.