Magazine issues » December 2011

HEDGE FUNDS: The storm after the calm

Stormy-skyAsia’s hedge fund industry appears to be growing again, but the barriers to entry for newcomers are higher than ever. Nick Fitzpatrick reports.

The remarkable growth of hedge funds that invest in Asia appears to be back on track now that the pain of the financial crisis has receded. September’s performance may have been a bit disappointing but, overall, the environment appears good.

Fund launches are increasing after a lull that began in 2008 and ended after record investment performance in 2009.

But the financial crisis has changed the way of doing things among Asian hedge funds, many of which are domiciled offshore in places like the Cayman Islands.

A lot of money has been going to bigger managers in the past year because of critical mass, says George Saffayeh, a partner at Ernst & Young in Hong Kong.

This is backed up by figures from Eurekahedge, a hedge funds data provider based in Singapore. Figures show the number of funds managing $50 million (€36 million) or less has increased from 54% in 2007 to 64% this year. The suggestion is that new launches have not attracted much capital and that most allocations since the middle of 2009 have gone to larger funds.

As well as critical mass, there is another reason why this may be. “A lot of institutional investors expect the right infrastructure from day one,” says Saffayeh, adding that it is the larger managers that are more likely to have the resources for this.

Costs associated with rolling out an institutional-grade operation are an issue for start-ups, of which there have been many. “A lot of successful fund managers are looking to spin-out from the large banks to start their own hedge funds. But at the same time, the barriers to entry to start a fund are becoming higher, which is making it more difficult to successfully accomplish that,” he says.

Adam Wallace, senior product manager, hedge fund services, at JP Morgan, says that, traditionally, hedge fund managers were western, but there is now a “fundamental shift” in industry development.

“Local players, including local prop trading desks which have been spun-out of banks, are playing an increasingly central role, in conjunction with fund managers from the United States and Europe, who are moving to establish an on-ground presence in Asia,” Wallace says.

Harder though it may be to set up a hedge fund, the potential for business development in the region is difficult to ignore.

“Globally, we are seeing institutional investors increase their weighting in alternatives growing from 14% to 20%, and we expect to see a similar trend in Asia,” says Wallace, quoting from a recent survey by JP Morgan Asset Management.

If that is the case, then figures from Cerulli Associates published in October will stop hedge fund managers in their tracks. The consultancy firm predicts that assets under management in Asia ex-Japan and Australia are expected to nearly double to $4 trillion by 2015.

Fund firms and providers in Hong Kong and Singapore also offer anecdotal evidence that Asian investors will repatriate some of their international investments back to the region in the near future. Although it does not automatically follow that alternative managers will pick up a significant chunk of that, the number of spin-outs and launches suggests they do try.

The number of closures is also falling. Between July 2009 and September this year, Eurekahedge found that a total of 351 new hedge funds had been launched, while there had been 236 fund closures. This indicated the return of a healthily growing population, the firm said.

The growth of the Asian hedge fund industry has been remarkable. Since the end of 2000 and to September this year, the number had increased six-fold from about 200 to around 1,300.

Assets have poured in through the same period. Funds had less than $20 billion in 2000, but had $135 billion at the end of August this year.

The financial crisis proved a watershed moment for hedge funds that invest in Asia, which demonstrated their ability to offer downside protection.

Nevertheless, Asia ex-Japan hedge funds also finished September in poor fashion with losses of 5.95%, their worst performance since October 2008.

Hedge_funds_boxThe increased number of local spin-outs has been prompted by the United States’s Dodd-Frank Act, which restricts banks from trading their own money. 

One recent start-up was Azentus Capital Management, run by chief investment officer Morgan Sze, a former global head of Goldman Sachs Group. Azentus is registered with the Hong Kong Securities and Futures Commission. This was not a small start-up; it launched in April with $1.06 billion, according to Bloomberg, and was said to be the largest launch since at least 2007.

The infrastructure issue said to face many start-ups since the financial crisis is created by institutions, both in Europe and Asia, that have become more sophisticated in their requirements. Some want to see a division between front and back offices, and to see that someone assumes responsibility for risk, says Wallace.

“Since the crisis, virtually all sophisticated investors are looking at operational infrastructure. As an example, one very large regional fund has attracted capital with its solid operations despite a flat performance.”

Counterparty strength is also important. “Funds with very few blue chip counterparties have low AuM and life expectancy,” he adds.

As more assets come into the region in line with the Cerulli prediction, perhaps the industry will see more “onshoring” of alternative managers in line with a more on-the-ground presence in portfolio management. The Cerulli research was partly sponsored by Korea’s Mirae Asset Global Investments, which believes local managers have an informational advantage over foreigners in providing outperformance.

Over the past four years, Hong Kong and Singapore have gained substantial market share in terms of head office locations for Asian hedge funds, attracting them away from New York and London. This has been aided by the expansion of service providers in the region.

With portfolio management, operations, clients and assets all sitting in the region, it would look increasingly bizarre if regulators let the situation continue where their biggest alternative managers incorporate in the Caribbean or Luxembourg.

©2011 funds global

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