Japan's Zombie Hedge Funds

"On the plus side, death is one of the few things that can be done just as easily lying down."

Woody Allen
Film Actor & Director (1935 - )

Like a bout of the Avian Flu, more and more Japanese specialist hedge funds (many of them long/short equity) appear to be in a death spiral. Not many years ago there were over 200 hedge funds in New York, London, Singapore, Hong Kong, S.A.R. and Sydney commanding combined assets in the range of US$20-25 billion focusing almost exclusively on the Land of the Rising Sun. Today, that number of funds is closer to 80-100 and the AUM managed is closer to US$7-9 BLN. Yikes!

"Zombie hedge funds", in this case are Japanese specific funds/firms which have undergone a steady and swift loss of AUM: initially from foreign FoHF investors, U.S. and Canadian pension plans and are now "hanging on" for dear life with a few million here and there from local Japanese investors; and that lifeline is soon to end.

Many prime brokers already have their own list of zombie managers and are not likely to steer some of their well-heeled investors in their direction and for obvious reasons.

Sad to say, many investors have abandoned the steady stream of double digit losses and have been fed up with the usual excuses - unexpected volatility, lack of liquidity, poor sentiment, program selling by institutions, lack of IPO activity, economic recession (or the best one yet), the Nikkei 225 is down so we can't produce any alpha!

In fairness, even Asia's "best" hedge fund producer, John Zwanstraa, has had a tough June and July in terms of performance. And one worry might be that Japan's zombie hedge fund phenom might spread to other locations (like China). So far, that hasn't really happened even though emerging markets have certainly moved down the global investor priority list although the Beijing Olympics might prompt a fresh inflow of investor interest in the short run.

But, based upon the performance number through July from hedge funds covered by HSBC Private Bank, the following are candidates for this author's Zombie hedge fund status given their negative YTD return and low AUM figures: Blue Sky (Michael Hill); GAM Equity Hedge Fund (Lesley Kaye); Henderson Japan Abs Return Fund (William Garnett & Jeremy Hall); Melchoir Japan (Ken Nishizawa); Myojo Japan Long Short Fund (Makoto Kikuchi); Odey Japan & General Inc. US$ (Alex Griffith); Platinum Japan Fund (Kerr Nelson); WF Japan Fund Ltd A/1 (Peter Ferry).

Each of these funds and possibly up to an additional 10-15 more are what I would call "zombie hedge funds" - unproductive and unloved by the global investment community with the clock definitely ticking in terms of being a long term viable business.

As we head into the second half of the 2008 calendar year a few of these may very well shut down for good, ending a sad chapter in hedge fund development in Japan and Asia. Mahalo.

Institutional Investors Expected to Buy More Fund Product, in 12-24 months

"The war of the giants has ended; the quarrels of the pigmies have begun"

Sir Winston Churchill
U.K. Prime Minister (1874 - 1965)

Reportedly pointed comments from a number of U.S. public pension plans about their willingness to significantly step up alternative investments is worth noting. When the NY Common Retirement Fund (US$153 billion in AUM), South Carolina Retirement System (US$29 billion), Teachers Retirement System of Texas (US$106 billion in AUM), New Jersey (US$77.7 billion in AUM) and others are all expected to significantly step up allocations to alternatives then something BIG is going down.

The reason for all the talk of institutions "going alternative" is the plain fact that passive investment in plain vanilla equities and fixed income have all gone down the tubes in the first half of 2008. For example, when the MSCI World TR USD Index loses minus 10.35% and the Lehman Global Bond Aggregate up 3.53% then a certain amount of worry sets in. The same type of concern is now logically facing many large Asian institutional investors; specifically, Japanese pension plans and life (and non-life) insurance companies.

As we have previously estimated, the total of Japanese institutional investments in hedge funds (single managers and FoHFs) is likely to be be somewhere just under US$60 billion which was the high-point a couple of years ago - or until financial institutions started to cut back due to Basel II considerations.

As the average Japanese institutional investor is currently allocating anywhere from 6-12% of total AUM in hedge funds one might expect recent poor performance in traditional long-only product to lead many of these investors to re-up their allocations to hedge funds, private equity, real estate and commodities.

It is conceivable that hedge fund allocations might increase to 15-25% of the average Japanese institutional investor portfolio over hte medium term.

Now is the right time to market to these institutions especially if alpha producers have non-correlated positive return funds to offer. And in the current environment that might be easier said than done.

Expect trust banks, life insurers and non-lifers to listen intently, only this year, they might actually make allocations. Their fixed liabilities driven by increasing numbers of retirees depends on it! Mahalo.