Mortality Rate Of Asian Hedge Funds

Funds which closed down since the beginning of 2008

SIEWLING LAY, CAIA, SENIOR ANALYST, GFIA

Fund closures and startups are an integral part of any hedge fund universe. Although the rate of closures picked up since the onset of the credit crisis, there’s always a healthy revolving door of funds each year. Asia is no different.

In this paper, we take a look at the profile of funds which closed down since the beginning of 2008. Using Asiahedge’s database, we filtered out the funds which were classified as liquidated, and also included others which our own research had identified as dead funds. We then identified the month each fund died, as being the month it stopped reporting to the database. Note that this is an assumption, because funds can and often do stop reporting performance figures months before they actually cease to exist. Also, even if funds report performance until the month they closed, the final valuations of the funds, on which investors are paid, could also differ from the values reported to the database due to various errors and assumptions in the calculation of the NAVs. Finally, as many investors know from experience over the last couple of years, funds rarely extinguish neatly on an identifiable date; they usually expire messily over months or even years as the liquidation process (of the underlying assets and of the fund structure) rolls on.

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However, we believe our assessment of date of death generally marks the point at which the fund would have been judged to have retired from public life. Our universe of dead funds consists of 381 names which included funds that ceased to exist up till December 2009. A breakdown of the funds which closed over the years by strategies revealed that close to 80% of these hedge funds were running equity long short strategies. This is much larger than the proportion of managers running equity long short strategy in the Asian hedge fund universe. Being the biggest single country hedge fund universe in Asia, as well as a source of recurring disappointment to investors, Japan naturally saw the biggest number of fund closures over the past nine years.

In terms of the number of fund closures each year, a steady pick up since 2001 can be observed right through 2007, which is naturally a function of the growing universe. However, with 129 closures, 2008 saw the biggest number of funds shut down, a figure which is more than double the number in 2007. The figure then normalized again in 2009 which saw about 82 closures.

The picture is largely similar when viewed as a percentage of the total universe. Historical attrition rate seemed to hover between 5% and 9% before shooting up to 19% in 2008. That figure fell to 12% in 2009.

Funds that shut down before 2001 were generally in operation for less than two years before closing shop, while the average life span of funds that shut down in subsequent years increased gradually to slightly over three years in 2009. This accords with the commonly voiced strategy of start-ups, especially those where the principals have an investment banking rather than fiduciary background, that they will “give it three years” and fund working capital accordingly.

In terms of strategies, 2008 saw a disproportionately large number of Japanese hedge funds shut down. 2005 was one of the best years for Japanese hedge funds in terms of performance, resulting in a huge wave of startups. Many of these could not survive the tough investment and asset-raising environment subsequently, and eventually shut down. In fact, of the 139 Japanese hedge funds that closed over the years, 52 (that’s close to 40%) occurred in 2008. Indian and Chinese equity long short funds also had more closures in 2008 than average over the past nine years.

As the total number of closures slowed in 2009, a decrease in the number of closures can be observed across all strategies, though more notably in the number of Japanese hedge funds. Overall, the proportion of equity long short strategies closures reduced from 88% of the universe in 2008, to 73% in 2009.

To understand the effect of performance on fund closures, we then look at the aggregate performance of funds for the five year period before they shut down. Quite surprisingly, these funds had actually outperformed the benchmark, the Asiahedge Composite index, for much of their lives, until immediately before closure.

Despite outperformance in their early years, hedge funds that shut down in recent years had underperformed their peers during the tough market environment of 2008-2009. Making larger than average losses resulted in underperformance of these funds in 2008; however those that managed to survive 2008 but failed to do better than their peers in 2009, also saw investors eventually leave.

Although performance may not be the only cause of funds shutting down, there is no doubt that it is one of the key drivers (investors always weight the most recent performance highly in their assessment of a manager). Other more prominent, non-quantifiable factors include weak operations (which is now a key focus since the emergence of frauds), mismatch between investors’ expectations and the risk profile of a fund, and the disappearance of opportunity sets.