Asia is now perceived as a major component of global wealth and there is high expectation that Asia should be the next great source of hedge fund capital. However, there is a measure of disappointment at the level of flows to date, especially amongst local Asian managers. Once you start to scratch the surface of this region, you quickly find that Asia has a diverse group of investors, each with a very different philosophy. We can’t easily generalise about any specific group, but just to start with, we should split Asia into three significant sub components; Japan, Australia and the rest of Asia.
Japan has been a significant hedge fund investor for many years through 3 main groups; bank proprietary capital, insurance companies and pension funds. Much of this investment was through fund of funds. Although the costs were higher, the investors felt protected from fund-specific issues and it was easier to adopt in their decision making process. A lot of this investment was seen as proxy for their bond allocation. As a result, when the 2008 crisis unfolded their scale of disappointment was much higher than most global institutional investors and they liquidated many investments under stop losses. Any use of suspensions and gates by hedge fund and FoF managers was perceived more as a breach of risk management principles rather that a valid attempt to preserve value.
In 2009 they were much slower to recover than other investors and missed the benefit of the rebound, though there now seems to be some level of new investment. One of the recent trends in Japan has been the further reduction of local equity in pension funds, at a time when bond yield are at record lows. This has brought about a need for alternatives once more; though it now seems better understood they are not a proxy for bonds. Transparency and liquidity are very important to Japanese, especially for capital efficiency with the banks which are cash rich but capital poor. Through structure and regulation, many end investors in Japan need to invest through an onshore intermediary. We are now seeing Japanese financial institutions trying to build more of this product in-house, rather than use a global financial institution’s product.
Australia benefits from a large savings pool due to the high level of enforced pension saving. This falls into 2 main pots; large government and industry super funds, and self managed super funds for the higher net worth.
The large super funds already own such a significant portion of their own equity market that there is a constant need to find alternatives. Unlike most Australians they are exempt from some of the tax issues that restrict others from investing in offshore funds. Their first move in to hedge funds was via fund of funds and product created by the large quantitative and systematic managers they were already familiar with. We are now seeing a move into more globally diversified single manager portfolios and we expect that, with time, this will be one of the more significant of institutional hedge fund investor groups in the region. There is huge sensitivity to cost which can prove a hurdle in negotiating terms.
The self managed super funds tend to select managers off a platform, though these managers will need to be locally structured. There are a number of hedge funds raising large amounts of capital on these platforms. In many cases they don’t even brand themselves as hedge funds. Many are long biased equity long short funds and are competing as an alternative to regular equity investment. We have yet to see many global hedge fund managers set up structures to raise funds from this market.
A lot of the wealth in the rest of Asia is not in traditional institutions, but is in the hands of governments and tycoons. It is well known that the governments are trying to diversify their reserves through the investment of Sovereign Wealth Funds and many have hedge fund initiatives though in most cases the investments are highly confidential and not officially reported.
Given the scale of wealth in the hands of tycoons and other high net worth investors, the amount invested in hedge funds is relatively modest. Ultimately this is because much if Asia is still first generation wealth and many are still focused on making rather than preserving capital. It is also still rare to see a family sell out of their business, which is often the catalyst for setting up a family office with a more formal structure. In many cases in Asia, the line is blurred between company and family investment. However, it is growing from a relatively low base and will continue to grow especially as many families go through generational change.
Even the private banks in Asia have a very different business mix than those in Europe. There is much more focus on equity and equity derivative product than on wealth preservation. Traditional institutions in the region are still relatively conservative with a strong home bond and equity market bias. A few have ventured into hedge funds but this is mostly through investment in one or two fund of funds. There seems to be little impetus for this to change. In North Asia a few of the countries are quite restricted on investment and some of these investments including hedge funds have been done by way of a structured note. Some of the experience has not been good as the structure too often drives the investment, rather than the quality of the underlying investment.
The vast majority of hedge fund investment of Asian investors is into global funds and not local managers, with the notable exception of the Australian SMSFs. This should not be a surprise as local hedge funds tend to be local equity related strategies and investors are trying to diversify more. Local market hedge fund strategies also often lack the scale. Given the size of the region’s equity market capitalisation, stock loan availability is small, credit markets are small if we exclude restricted markets and many currencies are restricted. Therefore, local investment in local fund managers has been very limited to date and the majority has been into top 50 global managers.
For many structural reasons, the wealth of Asia is not proving that easy tap for the hedge fund industry, nor is it likely to support the growth of a local manager community in the near term. It will still be dominated for some time by a few significant groups investing globally. Australia is potentially the market that could be the first to grow a broad institutional investor base. It could be a generation before the rest of Asia follows this path.
Richard Johnston is managing director of Albourne Partners, based in Hong Kong