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Hedge Funds in Asia

Monday, March 02, 2009

Long Short Equity Suffering Confidence Crisis

"Victorious warriors win first then go to war, while defeated warriors go to war first then seek to win."

Sun-Tsu (circa 400 BC) The Art of War, Strategic Assessments

A vicious cycle is afoot in Asia (and globally), and is threatening the very viability of an ongoing once vibrant, Asian hedge fund industry. The disappearance of market beta and the continuing theme of poor absolute performance carrying over from 2008 into 2009 will trigger more "silent fund shut-downs" which has apparently reached 2-3 managers per day so far this year as investors pull monies and retreat to cash or cash-like equivalents.

The previously most active sponsor of long/short managers in Asia were the fund of hedge funds based in the U.S. and Europe. They used to represent around 35-40% of all allocated monies to hedge funds in Asia. More stable and long term investments by so-called institutions like U.S., Canadian pensions and/or endowments represented a fairly small sliver of total monies allocated (probably around 10-15%).

Much of this never got it allocated as they were the most skeptical about the skill of the region's managers as well as big issues of scalability of their business models.

These investors initially preferred to get exposure to Asia in their portfolios through their allocations to NY and London-based multi-strategy managers like OZ, Ramius, Mariner, Highbridge in the early and mid 2000s. For local expertise in strategies like so-called activism they often went in via local specialists, although this broke down with a number of scandals in Japan in 2006 related to MAC Consulting.

According to data from HSBC Private Banking, YTD performance for the those managers with a Japan Long/Short Equity strategy has been down -1.60%, with the only saving grace a sparse number of multi-strategy Asia shops like Bennelong, Artradis and PMA (Sparx) which have managed to eke out positive returns for the most part.

This is ultimately the only way to foresee any modest revival in investor interest in the region: absolute performance, including capital preservation for the sophisticated investor. The alternative will be that the investor will opt for more cost-effective methods of buying exposure to the region's beta once a bottom has set in; and a bottom will eventually set in.

All manner of service providers are also suffering from the downturn in the hedge fund business and are laying off staff or downsizing accordingly. Things have gotten so bad that the much heralded annual hedge fund conference hosted by GS Tokyo in November may be cancelled. So the short term situation is bleak.

Another manifestation of the current regional malaise is that Singaporean authorities are doing what they can via tax policy to entice some of the Hong Kong business to relocate onto their shores.

It would be wiser to establish a region-wide initiative to encourage the development of a single, region-wide tax and bureaucracy for new or migrant fund firms from the west. They should also look to increase the number of derivative instruments useful to hedge outright equity positions over a number of exchanges; lower margin requirements and generally create an attractive environment for long term participation and investment by global hedge funds looking to escape the inevitable "heavy hand" of legal and taxation that is coming in the U.S. and in Europe.

Now is the golden opportunity for Asian authorities to take a united stand to promote an industry to enhance their capital market development for the coming global market rebound. Asian consumers are almost certainly going to play a key role in that rebound.

And as the regions banks suffer in unison with their western brethren it is important too for cash-rich institutional investors in Asia to team up with hedge funds in order to channel capital into profitable, high growth industrial ventures in their own backyard. They can learn from the experience and skill of hedge funds. Capital needs to be recycled closer to home.

If this is done, it very well may be a new era of growth investing via long/short hedge funds will take off in Asia spuring new strategies and profitable opportunities. The clock is ticking. Mahalo.