Asia 25 (2007)

Introduction

PHILIPPE TEILHARD, FIMAT
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Asia's hedge fund industry is much younger than its European or American counterparts, but no less dynamic. Managers in this part of the world are being pursued by investors from outside the region seeking investment talent capable of generating alpha in what is already a high-octane market. It is a good time to be running a hedge fund in Asia. The growth figures speak for themselves. The numbers vary slightly depending on the database being referenced, but in 2001 there were approximately 100 Asia-based hedge funds, whereas now there are over 700.

Asia's hedge fund industry does not have the same length of track record of either the European or the American industries, but it has been witness to three distinct waves of hedge fund innovation.

The initial, entrepreneurial wave of managers, who established their businesses to run money in the 1990s, is heavily represented in the Asia25. A number of firms in the Asia25 have been running alternative assets since the early days, and endured the hostile climate that followed in the wake of the Thai baht crisis, when hedge funds were the favourite whipping boys of Asian politicians. These are the firms with asset bases north of a billion dollars, with multi-manager characteristics, and with the strong global investor relationships that have helped them to build up the brand, the gravitas, and the critical mass to make the Asia25.

A second wave of hedge fund managers arose at the turn of the millennium that could be described as the more opportunistic, adventurous players who recognised that the global equity bear market, and the collapse of the technology sector, heralded opportunities for hedge funds in this region as much as anywhere else. Many of these hailed from long-only equity managers in Asia as well as beyond. Not all have survived, but those that did have contributed to the ranks of experienced long/short managers that are now so in demand from institutions seeking exposure to China, India, and other regional emerging markets.

The final wave of managers, many of whom are just starting out, represents a new generation of seasoned Asian hedge fund managers that are leaving the existing, established hedge fund organisations, including typically those in the Asia25, to set out on their own. Frequently, they have been mentored by the founders of these firms, and have earned their stripes managing money with a short book. Most importantly, they are seasoned investors in the region's markets, and can bring this experience to bear when generating alpha for their investors. We expect to see some of this Asian new wave entering the ranks of the Asia25 in the not too distant future.

Different challenges

As a region, Asia presents hedge fund managers with a unique set of challenges.

As a market it is not as homogenous as the American or European markets. Many countries are still classic emerging market plays, with the red tape and political interference that goes with this territory. At the same time, managers have access to well-regulated liquid securities markets in Australia, Hong Kong, Japan, and Singapore. India is also much in demand these days as investors buy into the sub-continent's macroeconomic story.

Successful managers in this region, like those in the Asia25, have been able to deal with the variety of regulatory environments they are presented with, including restrictions on shorting, and indeed sometimes a lack of loan stock. Outside Japan, for example, a pairs trading strategy is difficult to implement, leading to more emphasis on volatility arbitrage and relative value strategies.

We are now seeing Hong Kong and Singapore competing for the hedge fund dollar, with flexible regulatory regimes, attractive fiscal policies, and solid infrastructure on offer to start-ups who choose to do business there. Whilst Hong Kong undisputedly remains the gateway to China for key mainland company analysis, both centres are witnessing an increasing number of service providers on the ground competing for hedge fund business in Asia, and this is helping Asia's larger funds to improve their levels of operational efficiency. As the number of funds with over a billion dollars under management increases, so too does the emphasis on the infrastructure they will have to put in place to stay in that club.

Although the largest manager in the Asia25 is based in Japan, that country's hedge fund industry remains relatively small, despite the size and global importance of its securities and asset management markets. This has much to do with the local attitude of Japanese investment professionals who still regard breaking out of banks or institutional asset management firms to set-up independently as a risky and unusual move. Also Japanese institutional investors historically have been looking internationally to diversify their inherent exposure to domestic assets and have extended this habit to alternative assets investing. This is changing slowly, however, as continued low interest rates and a lack of volatility in the Japanese equity market mean more large Japanese investors are now starting to seek alternative options. This could mean new opportunities for local hedge funds that understand both their market and their client base.

But as ever in Japan, new parameters such as Basle II and a re-focused FSA may lead to tighter rules, especially for regional banks, which may result in capping expected developments.

No review of the Asian hedge fund scene is complete without a mention of Australia. Here, there are some large funds with very much a global outlook on their investment activities. It is also an important regional market for investment, with large superannuation funds that have the sophistication and expertise to run very large alternative investment portfolios. Although hindered by its far away location and low capacity of its own equity market for inward investment opportunity, Australia has been able to nurture some large foreign focused managers specialising in derivative based strategies, and they have done so very succesfully. It will also be interesting to see the role Australian institutional investors play in the growth of the Asia Pacific hedge fund story going forwards.

Where to now?

Asian funds are still recovering from the credit crisis hangover, and like other managers around the world, bracing themselves for what comes next. But we are also seeing a maturing process as the leading managers take on the characteristics of multi-strategy shops, and become acquisition targets for large groups from Europe and North America like SAC, RAB Capital, Tudor, and Millennium.

If there is a constraint on the growth of the industry in this region, it has to be one of capacity. Many markets are still emerging, and outside the largest bourses like Tokyo, Singapore, Sydney, and Hong Kong, there remain liquidity issues that could put a brake on the speed at which local managers can incorporate capital flows into their strategies.

With local markets achieving such phenomenal numbers – China, for example, returning over 90% in 12 months – it is harder for local hedge funds to make their case to local investors at the moment. However, with a market correction and more difficult times for long only funds, Asian hedge funds could well experience a new phase of investment growth beyond that fuelled by the current global interest in emerging markets.

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