Asia Hedge Funds: A Dying Breed

"Men occasionally stumble over the truth, but most of them pick themselves up and hurry off as if nothing ever happened."

Sir Winston Churchill, Prime Minister (1874-1965)

It is indeed an inconvenient truth. Recent news that the grand old daddy of Asia-based multi-strategy hedge fund managers in Artradis is closing cannot be a shock. That the same fate has also gripped Sumitomo Trust & Finance with their Tactical Equity Concepts suggests that more of the same is coming.

The fall of Artradis is not a Japan-specific phenomenon. The fact that the firm once wielded upwards of $4 billion in AUM meant that it found some appeal to institutional investors seeking modest returns (6-8% net of fees) but with very low volatility, and chance of loss. When markets were rational this was a sound strategy. Then when 2008/09 hit and losses ensued, the story became less appealing - what had been touted as a low risk vehicle suddenly suffered steep losses and a flood of redemptions in not-so-liquid markets. Performance was damaged and reputations too. Many FoHF investors, HNWI and private banks simply disappeared as investors in the region's hedge fund industry and Artradis suffered.

After spending many years building up an institutional-quality firm, once the AUM start to leave the front door the troubles inevitably begin: cost cutting, monthly then annual performance is even more scrutinized, fees are negotiated lower to retain existing investors etc. A vicious cycle begins, and ends with certain strategies being cut altogether in order to lower fixed costs as well as decisions about pumping even more principal cash into the venture - but for how long?

Finally, the decision to return AUM and an orderly shut-down. Game over.

The era of the "boutique" hedge fund manager in Asia is fast coming to a close. First off, it really is not that easy to produce 12-15% returns each year in the public markets - not without risking initial capital that is...

Second, the cost of capital for many managers has increased since the crisis. That means that it has started to become more expensive to operate, especially if one is in a high rent area like Singapore or Hong Kong.

Third, with most strategies in Asia taking a long-short route it is not surprising that when those traditional, long-only indices suffer the performance ability of the underlying hedge funds also suffer.

Four, few of the regions banks, or institutional investors currently have an appetite for seeding or taking a private equity type approach to supporting a boutique hedge fund operation (Orix notwithstanding). Perhaps the right kind of deal simply has not yet come along...

Fifth, the end investors themselves have run to the hills, chasing commodities, small cap stocks in certain countries and even into bank deposits which are starting to offer higher returns now that the region's central banks have started to tighten monetary policy in light of an increasing inflation threat.

On the bright side, the way is clearing now for more of the larger US and European trading shops to gain "market share" in terms of access to deals, flow, stock borrow and the like as the remaining primes start to suffer intense competition to justify their own steep overheads in the region. Expect a few of them with bloated staffs to quietly release employees and pull back from prime brokerage as the business simply starts to dry up. 2011 will be an even tougher one for the industry, in particular if one is focused heavily on Japan. The approximately $15 billion in AUM may easily fall to $8 billion by year end. I hope I am wrong. Mahalo.