Asia Pacific alternative fund specialist GFIA has recently published its views on the current state of play in the Asia Pacific alternative fund industry. Peter Douglas, GFIA founder and chief executive, comments that despite witnessing the largest performance-based losses among all other regional mandates, Asia ex-Japan funds have seen a net asset inflow of $2.7 billion in the first quarter of this year, bringing the current AUM to about $135 billion.
Equally, investors appear to continue to crave exposure in Japan, which saw a net inflow of $0.5 billion, despite losing 1.9% (as measured by the Eurekahedge Japan Hedge Fund Index) in the first quarter of 2014. Douglas reports that overall, Asian hedge funds are slowly recovering assets lost since their 2007 peak. He concludes: “In our experience, this rapid inflow of assets, alongside what feels like increasingly volatile performance, is typical of periods immediately before market peaks.”
Douglas finds that current investor appetite for Asian/Japanese hedge fund managers is modest but growing. Historically the appetite for Asian and Japanese managers tends to accelerate towards the top of a market cycle, then fall away rapidly (even for market-neutral or RV strategies). Douglas says that GFIA has no particular market view: “but a ‘prudent man’ might observe we must be closer to the top than the bottom of the current cycle. So although cyclically we’re seeing some accelerating inflows, the secular trend is more modest.”
Turning to institutional investment, GFIA has observed that many of the larger institutions remain more comfortable allocating either to Asian strategies run from outside the region, or to Asian strategies run within the larger global asset-gatherers. “While this approach certainly leaves money on the table compared with allocating to local or smaller skill-based managers, at least it gets capital to work, and allows organisations to get a better feel for what’s possible in Asia,” Douglas comments.
Funds of funds are still suffering in the Asia Pacific region with what Douglas describes as minimal to zero interest from investors. “The funds of funds that are surviving have nearly all changed their business model, either to a consulting approach, or to seeding or other principal-like roles,” Douglas reports.
Long-only stock-pickers are in demand, as Douglas finds that Asia’s mix of liquid but inefficiently priced markets makes stock-picking a much more intelligent approach than benchmarking, or, he says, worse, ETFs. “The good ones are very careful about not taking too much capital which means they can pick their investors,” he comments.
Bellwether Japanese managers have seen strong inflows as investors look to rebalance their approach to the world’s second largest developed economy. However, Douglas reports that smaller Japanese managers, however good their numbers, still struggle to engage with investors.
China is making a reappearance, according to Douglas, as the new PRC cabinet focuses on creating a financial system robust enough to open to the world, a development which is reassuring to investors. “And from a simple beta perspective, it’s hard to argue against the value story of Chinese equities,” he says.
Asian fixed income is enjoying steady growth as it develops into a real asset class, but with comparatively few real experts, meaning there are alpha returns available. Douglas says: “Different managers take very differing approaches, however. The better equity long/short managers are holding their assets but there’s little fresh appetite. And volatility trading is virtually dead, in the face of eternal QE.”
Asset size in the Asia Pacific hedge fund industry remains a key sticking point. “This is the biggest disconnect between global capital and Asian managers,” Douglas reports. “We’ve kept an eye on the relationship between size and performance in Asian hedge funds since the late 1990s and although the sweet spot moves around, the range is typically centred on $400 million. The credible skill-based managers therefore cap assets at perhaps $1 billion or so, and we rarely see multi-billion managers creating much in the way of interesting returns. But we find that many investors, especially in the US, see that $500 million is the starting point for a conversation, meaning that by the time the allocator is comfortable to invest, the best performance has gone and the manager is closed, or much less interested in building a close relationship.”
GFIA’s strongest piece of advice is that investors need to allocate small and early. “You’ll develop a better relationship with the manager, you’ll get better performance, and you may well find that you’ve invested at a better point in the market cycle,” Douglas says. He finds that external capital going into start-up deals tends to be tightly structured, either as professional seed capital or with some type of preferential fee deal which involves some degree of ownership of the management company.
He finds that very few investors invest on day one without some sort of privileged status within thefund. However, there is good news in that there are now more sources of seed capital in Asia for managers who are prepared to do some sort of a deal. Douglas had found that there is a strong correlation in the Asia Pacific hedge fund world in the positive relationship between launch size, and subsequent underperformance. Small launches are good and investors should mostly avoid large launches, despite the fact that the occasional billion-dollar plus launch seems to attract the attention of allocators.
Douglas finds that hedge funds in the region have changed their role in the investor’s portfolio, moving from being a straight provider of returns to a role where they offset or mitigate risk. This means that nowadays, institutional investors increasingly want low-volatility, high-alpha returns, which are hard to achieve in an emerging market such as Asia. “We can get comfortable with only a very small universe of ‘pure-alpha’ managers in Asia – most have taken their portfolio risk and packaged it, ticking patiently, as tail risk somewhere else in the portfolio,” Douglas says.
In terms of launches in the region, Douglas reports that there are a steady number of new launches but appetite for the new funds is bumpy with the occasional high-profile fund launch attracting a great deal of interest, but for the rest, the managers are trying to garner support. Douglas also finds that the quality is uneven, with more of what he calls ‘cosmetic launches’ appearing, launches designed around the perfect due diligence questionnaire rather than designed to excel or where managers have a fantastic back story but not much experience of actually managing money.
Douglas also finds that there is a steady pace of attrition in the sector, which is normal, and usually due to funds or managers who find that they cannot make their business work and are forced to close down. This could be because the investment strategy didn’t work but is rarely because of an absolute catastrophic blow-up. Douglas finds that often, where principals have come from investment banks, the time horizon in which they need the business to be successful is too short. “They pull the plug after two or three years if they’re not making as much money in their business as they think they should,” he says. “Starting small no longer works in Asia (apart from the long-only stock-pickers, who can start small and grow incrementally) so often it’s clear at launch that the manager isn’t going to make it in their current form.”
Douglas also reports on what he calls a small but growing fund of ‘guerrilla’ managers with their own investment capital who exit the industry entirely and manage money outside the regulatory regime, driven by ‘vindictive regulation’. He feels that the dominance of regulation is creating an increasingly sophisticated and exciting shadow banking infrastructure which he finds exciting and feels will be the next growth area for the hedge fund industry.