In Asia, like in the Rest of the World, Hedge Fund Performance Matters

"Maturity is a bitter disappointment for which no remedy exists, unless laughter can be said to remedy anything."

Kurt Vonnegut, 1922-2007
Author

The number of global hedge fund managers will likely stagnate this year as smaller firms struggle to raise assets. This should come as no surprise. And guess what? The challenges facing firms will also impact Asia.

According to Eurekahedge, the database and third party-marketer, there were 628 Asia-focused firms managing 1,170 hedge funds in April 2008 versus 183 firms in 2000.

This author "guesstimates" that the combined AUM of hedge funds is still around US$200 billion although this is believed to be down 10-15% from 18 months ago.

It is worth remembering that the global diversification of the big, often-closed long/short equity, multi-strategy or relative value players that typically weigh in with the biggest assets in the regional stock markets.

As in the U.S. and in Europe (why should Asia be no different?) institutional investors, having suffered a performance battering ram in the first quarter of 2008, are now fishing for those big, behemoth single managers and fund of hedge funds that are most likely to "survive" and satisfy their institutional infrastructure demands.

While new fund launches are down in Asia, closures are almost certainly up (attrition rates running at 15% per year vs. an average of 8.5% globally from 2000-2006) - especially in Japan.

As long as performance continues to disappoint the trend is likely to continue. Eurekahedge data suggested that Asian hedge funds were on average minus 5.9% year to date versus minus 1.1% year to date for their global fund index.

The reality is that getting to the US$250 million mark for a start-up manager is probably necessary in order to garner institutional assets (from pension plans, the largest fund of funds, endowments and the like).

Performance, or the lack thereof, still dominates the decision by insitutional investors in their "invest or don't invest" decision in Asia. Frankly,when returns are sub-10% gross (which certainly was not the case in 1Q2008), people complain about 2-20 fees and rightly so. In any region of the world, it is the simple math which is drawing attention to the whole business model of hedge funds and forcing investment committees to ask: "are these strategies really worth it?"

For example, back to the 10% gross returns 10-2=8 8-1.6 equals 6.4%. And if the returns are up at 15% gross then the return to the investor shifts to 10.4% (15% gross - 2% = 13, 13-2.6 is 10.4%). So if managers can't generate at least 15% then the net of 10% is troubling, especially if the broad indices are up 8-12% in that time frame. Remember too that long managers have a better tax efficiency.

Maybe this is the reason that some of the money that might be fleeing hedge funds is flowing back into 130-30 products, index enhanced strategies and other low cost alpha generating products. For beta, there may be more cost effective ways to get exposure in the region.

So called "experts" tend to forget a simple practical fact that performance expectations for Asian investments tend to be higher than in other markets due to the reality of higher perceived risk facotrs. So even a 15% bogey (performance target) might simply not cut it for many types of investors given that the overall market volatility is so high.

On the bright side, there appear to be good opportunities in Asia investing in distressed assets, asset-backed lending to mid- and small companies, in M&A, in investor activist ideas, in infrastructure project financing and in market neutral strategies. And yes, many of these strategies might involve tying up capital in illiquid markets or strategies. But isn't that the M.O. of the big, largely successful managers in the rest of the world? You will need to go more illiquid and accept a longer lock-up in order to participate in the perceived 20%+ returns that exist in Asia.

All this assumes that the authorities do their collective part and not impose direct or indirect restrictions on hedge funds and other financial entrepreneurs. Mahalo!