Understanding the Asia Fund Performance De-Coupling Myth

"There are three kinds of lies: lies, damned lies, and statistics".

Benjamin Disraeli (1804-1888), British Prime minister

Asia is not the U.S.

It is not an island with mineral resources, a developed financial market infrastructure, and a powerful domestic consumption motor to keep it going. Never has been and still a long, long way from being in such a situation. But that has not made it attractive with followers highlighting cheap labor, a growing middle class, an entrepreneurial spirit of many of its peoples and the absence of a costly western-style social net for the sick and aged.

Ever since the early 2000's when the world witnessed a rebound in a moribund Japanese economy, and the BOJ effectively offered up a backstop to the domestic banking sector, western investors have been fascinated by the "growth story" of Asia - its products, its export orientation and its ability to offer up global corporations and billionaires. They are in the same situation as the U.S. in the 1920s...private equity will boom and public market gains will soon follow. This was the consensus.

For western investors deep in capital, they sought +20% returns to go afar and in some instances there were many markets and hedge funds that were able to deliver. Buy into Asia after a deep decline and ride it up, or buy "cheap" (levered) beta.

However, since the Great Market Depression since 2008 and rapid whiplash rebound in 2009 Asian markets have failed to pull away from the same impulses that have infected other developed markets.

In fact, many of their equity markets have fallen far further than their developed market partners. Global liquidity has pulled back as "risk-off" has taken hold. Export driven industries have witnessed sales and revenues collapse especially with self-imposed austerity taking grip all over Europe. The outlook is ugly too. Traditional market indices have fallen and Asia-specialist hedge funds have fallen too.

Asian hedge funds have produced ugly returns, often in the -10% performance range through calendar year 2011. Manager belts have tightened, employees laid off and the bulk of strategies have suffered from greater volatility as bank prop desks and capital has been pulled in. This author has said many times that 2011 would be a year of retrenchment in the industry and this will likely continue in 2012 as tough times continue and big money sits on the sidelines of capital markets including hedge funds. Hedge funds have to lived up to all the Asia hype!

The reality is that many Asian large caps generate a greta deal of revenues from export markets that are now in effective "recession". With domestic markets also subject to high interest rates in an effort to dampen inflation, now more than ever Asia is exposed with its growth intertwined with the fate of Europe, the U.S., Latin America and the Middle East. There has been NO decoupling through this cycle, nor should we have expected there to have been given how inter-related industrial product and market cycles have become.

Hedge fund performance of Asia specialists versus global specialists are equally dreadful. There has been no decoupling of performance. None. This year, overall hedge funds have been down around -7% while in Asia the numbers are -7% to -10%. Perhaps part of the problem is that the ability of capital to move more quickly from market to market has effectively arbitraged a lot of opportunities that might have appeared ten years ago, but are simply not liquid enough today. Plus there have been few IPOs to goose returns.

This author believes that in times of stress it is often in the private markets where well-capitalized hedge funds will be able to make a performance difference. Asset market downs are taking place over a number of industries and shrewd hedge funds that understand these pricing dislocations will be able to weather the short-term storm and come out of 2012/2013 cycle with pricing power and valuable assets, especially if they are food, water, energy or raw materials - all necessary for vibrant, growing populations in the region. Asia is not decoupling from the rest of the world. Performance problems are likely to persist. Mahalo!