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Hedge Funds in Asia

Sunday, October 24, 2010

Orix Hedge Fund Strategy - Ambitious or Misplaced?

"If little dreaming is dangerous, the cure for it is not to dream less but to dream more, to dream all the time."

Marcel Proust, (1871-1922)

Interestingly, it takes a Japanese leasing company to voice an ambitious hedge fund strategy, transforming its role as a distributor of a U.S. hedge fund into one of owner and emerging manager promoter.

Orix is no stranger to the hedge fund business as it has proudly boasted as being one of the earliest Japanese institutional investors in some of the biggest and oldest firms like Tudor, back in the mid-1990s. Their interest was a means to secure absolute returns from proprietary funds at a time when Japanese fixed income rates already low and falling while long-only equity investments were volatile.

Next, Orix got into the seeding business - choosing to focus on Japan and Asian strategy managers. Nice. That turned out to be a miserable failure. It seems that someone forgot to understand the power of correlation in a relatively concentrated portfolio. The company retrenched, co-investors fled and senior experienced managers were reassigned next window seats! This was sad. It marked a lost opportunity.

Orix decided to lean on an existing U.S. relationship with Mariner. This is a firm that has single strategies, fund of hedge fund strategies and a seeding vehicle for emerging managers and strategies. The typical profile of Mariner stresses low volatility and steady returns (except for 2008) that many think could be a useful and critical component for the investment world in Japan.

Orix wants to double AUM from $10 billion to $20 billion in 5 years. This implies a +20%
growth rate each year. There are very few firms with a strict alternative investment focus that have achieved this since 2007. The only types of firms that have managed very high growth rates have had low starting AUM, a solidly compelling strategy/niche, long-only strategies which are low cost or some special distribution prowess.

In my opinion, Mariner is not the firm that fulfills any of these goals. Performance has not been outstanding/notable, there are no compelling strategies (such as private equity or real estate or emerging markets), no long-only products (a feature of AQR) and certainly no distribution expertise, for example, into Japan's pension find market. For these reasons, I expect the relationship between Mariner and Orix to become strained as the existing product line does not solve existing problems.

Orix should focus on sorting out its real dilemma. That is establishing a stronger and deeper distribution platform into the Japanese market. To do so, they might be best suited to strike a deal with an asset management company, agricultural cooperative, a city bank or somehow with a pension consultant. Existing relationships will not do the trick.

Japanese institutional investors are seen as net sellers of hedge fund produce due to costs, poor performance in 2008/09, poor transparency and the imposition of gates (lack of liquidity). Orix would be best served developing a scalable money market fund that is liquid, performs better than regular money markets, and that does not have currency risk. They should also focus on infrastructure and real estate projects in Asia, as well as creating a vehicle to invest in natural resources such as through a private equity fund where the returns would be significantly higher than with a FoHF.

All of the above would assume that Orix senior management understand the real needs of Japanese institutional investors, the lack of value in a HFoF business as well as how they need to "fix" their investment management business.

Ultimately, they need to have a separate organization - perhaps via an IPO rewarding management along western lines and not as "glorified salarymen". If they are not quick to see these issues this will be yet another failed attempt by Orix to build a business, that they will fold and collapse away in 4 years. Ambition misplaced? It sure looks like that. Mahalo.

Friday, October 15, 2010

Japan-only Hedge Funds Slip into Growing Irrelevance in Asia

"A man is rich in proportion to the number of things he can afford to let alone."

Henry David Thoreau, (1817-1862), author, poet and abolitionist

The data keeps pointing to a very uncomfortable truth; one that has been in the making for a number of years. Stock market capitalization of countries in Asia are increasing in US$ terms almost everywhere - except in Japan.

As equity business tends to form the bulk of trading activity across the region's exchanges this has a big impact on hedge fund location, capital allocations, prime brokerage resources, income disparity across various exchanges and the use of direct market access technology for executing buy and sell transactions.

In the good old days, Japanese stocks were heavily traded, and their brokers were high on global league tables in terms of analyst coverage, investment banking business, IPO volume and equity traded. The rest of Asia was the rump with Korea struggling to break out. Hedge fund activity was rampant in the region especially when Japan was awash with liquidity, a stock market that went-wild in the 1980s only to stumble somewhat in the 1990s as deflation and a bank crisis hit the markets and market sentiment.

2003/04 marked a temporary reprieve as global hedge funds bought ahead of a government backstop behind the big banks. This, plus the promise to keep rates low, allowed investors to buy the banks without peril. Japan Inc. recovered and hedge fund AUM exploded together with their influence on the local exchanges and their activity at conferences, such as the GS Tokyo Hedge Fund Conference. Hedge funds dominated Japanese equity markets, and accounted for as much as 30-33% of Tokyo SE market capitalization.

Those days are no more. More hedge funds have closed than opened in Japan, however hard US and European prime brokers try to announce otherwise -- almost every other month!

The trend of equity market capitalization is a partial reflection of hedge fund activity in the region. Comparing 2006 to end of 2009 data, the value of Japanese stock market capitalization has fallen 28%. Over $1 trillion has disappeared. It is gone- probably to other markets in the region that offer more growth, greater liquidity, IPOs and generally more positive prospects.

And it is not only a case of FX translation too. Japan market cap now accounts for just under 23% of total Asia market capitalization which runs at around $14.4 trillion. Back in 2006, Japan market capitalization represented 40% of Asia market capitalization.

Just as Japan has slumped, Chinese equity markets are enjoying a period of incredible growth. The combination of Shanghai, Szechen and HK stock market cap growth now exceeds that of Japan by over $2.5 trillion. China now represents 41% of total Asia market capitalization.

With year on year growth also picking up in Asia ex. Japan big opportunities are now opening up to grow more hedge fund business out of Singapore, Hong Kong and a new batch of low cost centers with solid infrastructure as affordable commercial real estate is likely to be a negative factor for many firms in the coming years.

Indian stock market capitalization from 2006 to end 2009 has grown by 38%. Like other countries, a net phase in market development will be the extension of company coverage to include more mid- and small-cap stocks and the proliferation of indices that allow for passive (low cost) exposure by the region's institutional investors including banks, insurers, and SWFs.

Sadly, the prospects for Japan look bleak. Investors should be aware that the pan-Asian hedge fund strategies are more likely to produce positive alpha in this next investment phase. The days of a Japan-only strategy are pretty much heading the same way as their zombie economy. Long live a pan-Asia, multi-strategy hedge fund approach.

On a not totally unrelated note: in the same way that a few forward thinking Japanese companies encouraged the promotion of westerners to senior management and board level positions in the mid 2000s, they might want to now do the same to include more Asians at critical board-level decisions if they are going to be able to appreciate the medium-term changes going on in the region's markets. Japan has to get out of depending on capital to come to Tokyo, and instead allow capital to move out to where there are positive NPV projects in the rest of Asia.

It may be time to learn Mandarin, Thai, Tagalog and many of the other regional languages and cultures as corporate development including M&A activity almost certainly intensifies. Mahalo!

Tuesday, October 05, 2010

Wider Dispersion of Returns Points to Patchy Hedge Fund Performance in Asia

"If winning isn't everything, why do they keep score?"

Vince Lombardi, (1913-1970), football coach

According to recent hedge fund data (HSBC's Hedge Weekly #40) Asia's hedge fund performance continues to be patchy heading into the tail end of the third quarter and approaching the fourth. In fact, almost all categories continue to lag global multi-strategy managers that posted +6.75% on a YTD basis.

Asia's largest category of funds - those trawling pan-Asian equity markets - consist in the database of 18 funds (not firms) with AUM totaling $9 billion and YTD performance (on an equal-weighted basis) of -1.96%. The biggest gainer is Bob Karr's Joho Fund up 11.90% while the biggest loser was Everest Capital Asia with -12.26%.

In the small equity diversified Japan category with AUM of $1.238 billion for 7 funds, average performance was -0.24% with the largest gainer the Martin Currie ARF Japan Fund at +6.33%, with the largest loser SR Global Fund H - Japan with -12.82%.

Multi-strategy Asia specific funds also suffered a wide dispersion of returns but with overall performance -7.11%. This runs contrary to the performance of their global counterparts. It also runs contrary to the notion that they would be running more hedged arbitrage strategies, unless of course, they were more directionally positioned than previously thought. The largest gainer was LIM Asia with +2.92% while the largest loser was Artradis Barracuda Fund with -18.21%.

As we have already explained, investors looking at Asia should be particularly comfortable with NASDAQ type of return/volatility in a portfolio, and if you are not making the 15-20% returns then you would be better served taking a passive investment in a cheaper ETF that focuses on the beta. The other option is to focus on Asian fixed income and other private equity type deals even though the payback is likely to be longer, albeit with a high attractive IRR. Mahalo.

Fortress $41 Billion War Chest Coming to Asia

"Imagination is the one weapon in the war against reality."

Jules de Gaultier (1858-1942), French philosopher & essayist.

The announcement that a fully staffed operation will be established in Singapore in 2011 from one of the world's biggest alternative asset management firms, Fortress, fortifies a global trend to focus on emerging economies and regions. The fact that this is taking place from Singapore is also noteworthy as the destination of choice for global multi-strategy players.

Fortress will likely hold around 15% of AUM or $6.2 billion in firm assets in Asia over the next few years. This is likely to be an increase of $4 billion over current estimated levels. One way will be to increase the number of arbitrage opportunities generally in equities, currencies and growing local fixed income markets.

Like Och Ziff, expect an Asian-focused fund to be split off/created in the not too distant future. A second, broader strategy will be to launch a number of private investment vehicles focusing on private equity deals, infrastructure and even mining deals - all projects with positive NPV valuations taking IRR to +30% levels which may not be achievable in public markets.

Fortress expansion plans are a subtle reminder that the near-term opportunities in developed markets are likely to be subdued (i.e. low growth). A further reason for the move overseas will be to better establish local relationships with Asia's growing SWFs including CIC in China as well as with GIC in Singapore - helping those institutions with the execution of their own global investment strategies. It is also a play to get involved in the some of the biggest IPOs that are expected to take place out of Hong Kong as an increasing number of corporate names focus on growing their geographical footprint in the region.

Finally, Fortress may also be preparing to move corporate assets into a jurisdiction that might be deemed "friendly" given the continued pent-up antagonism by the US and European authorities (legal and taxation) against hedge funds in general. Overall, a sound move and one that is expected to be followed by other large US hedge fund players in coming months. Mahalo.