The Current Asian Hedge Fund Industry
The problem when overviewing the Asian hedge fund industry is starting with accurate data on its size. Many funds are selective in how they chose to distribute their assets and performance. Many, but certainly not all, provide data to some industry and databases. EurekaHedge estimates the Asian dedicated and Asian based hedge fund industry to total an AUM of $124.1bn while AsiaHedge estimates an AUM of $140.62bn as of January 2012. However, we are aware of 26 of the larger managers that do not report their data on such databases which manage another $38bn. As the average size of these funds is over $1bn, clearly many significant managers don’t report.
Some of the data we present is based on the more institutionally representative 89 Asia related funds we have on our Ongoing Due Diligence programme. There is around $67bn AUM in these funds, though actual total AUM of the managers is higher due to other related funds and separate managed accounts. Total assets of these managers are probably closer to $80bn. Most managers based in Asia undertake Asian strategies but certainly not all. If we remove the more globally centric managers from this list, such as the CTAs and truly global orientated equity managers, we end up with 82 funds with $65bn under management in Asia related strategies. As some of these managers have multiple funds, the actual number of mangers is 75.
There can be significant differences in industry size based on the treatment of long only boutique managers. They often charge fees similar to hedge funds but are they hedge funds? If we take the view that a hedge fund is a business model, then they are. If we consider are they part of an investor’s absolute return allocation or equity allocation, the answer is probably equity. Then they are not. There is around $20bn of AUM in this gray area.
We estimate around 75 managers have around 60% of the Asian hedge fund industry’s assets. The balance is very fragmented as many count up to over 1000 funds.
We can look at a strategy breakdown of the funds on our platform by number (chart1). The most obvious observation is that it is heavily dominated by long short equity strategies. Equity long biased are similar strategies but with net market exposures typically averaging over 50%. The next large group would be the combination of the multi strategy managers which have different strategy mixes so we classify them as diversified, event driven or relative value. Next is global macro though the managers in the region tend to have an Asian bias to local currencies and rates. They are relative small number of distressed, emerging market credit managers and CTAs, and not a lot of critical mass in other strategies.
We can also look at strategy breakdown AUM weighted (chart 2). This shows the industry is even more equity long short biased as they tend to be more of the larger managers. On this basis there are probably two strategies that are understated. CTAs typically get more of their assets in managed accounts so they are more significant than just the fund size would imply. Distressed mangers often have more assets in their private equity structures which would increase their relative size.
Ultimately it is not that surprising Asia is so equity dominated given restrictions on most countries capital accounts. There are four liberalized currencies; Japan, Australia and the two city states of Hong Kong and Singapore. Therefore, many other strategies have still limited viability. Even multi strategy funds will tend to be very equity dominated including long short, equity events, convertible bonds and equity relative value. The higher yield credit markets also tend to be quite equity correlated. Only currency and rates offers a limited uncorrelated alternative.
When it comes to manager location we are seeing a trend of more managers being based physically in the region. We can look at the data by head office location. Thirty-six percent of head offices of the funds are still based outside the region. Hong Kong is growing as the dominant centre. This has part been driven by the number of PMs who left global firms during the financial crisis and set up independent firms in Asia. When we look at where the funds actual PM is located, the trend to being Asian based is more pronounced. Only 24% still sit outside the region. The majority are based in Hong Kong and Singapore which are both friendly regulatory and tax environments. A few are based in Tokyo and China but they often tend to be structured as an onshore advisor with the actual orders being placed offshore. For regulatory and tax purposes they are not yet attractive centers for the managers to be officially based.
When we look at the challenge the industry faces in Asia, it is the impact of growing institutionalisation. In our experience, the last few years has seen growing institutionalisation driven by North America. This is especially true in the pension industry, whereas the endowment and foundations have always been significant investors. We still see it to some degree in Europe’s, Australia’s and Japan’s pension funds. The real driver of this trend has been the desire to avoid locking in the low yields of government debt, yet reluctance to take more equity volatility. We are also seeing a trend of these institutions moving from fund of funds to investing directly.
Family offices were one of the earliest investors in hedge funds, but in recent years have declined as a percentage. They are still active but the relative size is smaller.
Financial Intermediaries have been mixed, especially if the end investors are retail or HNW where interest has significantly declined. However, the institutional fund of fund business is more robust, though the trend is toward segregated mandates. More flexible co-mingled assets are declining.
When we consider the consequences of institutionalisation we would make the following observations:
Smaller numbers of larger investments as institutions tend to run one common global portfolio often with less than 25 managers.
More single global portfolios but less regional and thematic portfolios which were more traditionally run by financial intermediaries.
Pensions have very little appetite for high beta in their hedge fund portfolios as they have a separate allocation to equity.
Higher expectations for transparency and governance as seen in initiatives such as the Hedge Fund Standards Board and The Open Protocol.
Higher expectations for infrastructure.
Fee pressure to order to get larger tickets and longer lockups.
A “small” hedge fund in a global context is $1bn-3bn, which is traditionally large for Asia.
All of this equates to a “higher barrier of entry”. In truth it is only a relatively small number of Asian managers that can compete for this business. For managers too small to compete for institutional tickets the competition is severe. Asia managers traditionally relied heavily on European fund of funds which largely attracted retail and high net worth assets. This business is in significant decline and, therefore, so is the source of capital that many smaller managers relied on to grow.
For an Asian manager to compete for space in a global institutional portfolio, they have got to bring something more than the Asian beta story. Investors will ask if Asian long short is a differentiated alpha source. For a few managers the answer is yes but industry wide it is still unproven. In the case of China it appears good, whereas India has been poor. Japan scores surprising well. Asia long short is also highly correlated with global liquidity flows so it often fails to provide any diversity in a crisis. Many global managers also have an Asian component to their strategy as many global companies are still at the top of the value chain.
There is also the issue if Asia has more mispriced opportunities. We would argue the answer is yes but the ability to hedge is more limited, so it is hard to achieve scale. Once again the stress in a liquidity shock is higher.
Investors will ask what does Asia offer that is unique. The credit cycle is arguably different and we do see great opportunities in the illiquid space in areas such as direct lending, stressed and distress credits. We also see differentiated macro opportunities which provide opportunities in local currencies and interest rates.
The combined effect on the industry is that the big gets bigger and smaller managers are overlooked. The industry has barely grown but the large managers are getting an increasing share. There is a lack of interest in high net (>50%) hedge fund managers. The market now prefers either a lower net (<50%) hedge fund or a boutique long only manager. Smaller managers struggle to get institutional money and are subject to very fickle flows from financial intermediaries and smaller family offices. Even a large Asian manager can reach capacity very quickly, as in a global context their capacity is a relatively small number.
The environment is now tougher for new managers. The only successful recent launches have been from established hedge funds or internal bank hedge funds. There only have been 22 that met this criteria and started post 2008 with at least $50m, yet the odds of success are still only 50/50. A successful launch really needs over $100m and a fairly quick path to achieving $500m. The stronger launches are starting with 15-20 headcount and a comprehensive infrastructure. It is now very hard for a long only manager to start a hedge fund, though there is better appetite for boutique long only funds. Most prospective managers will now have to start their careers in large multi strategy or platform managers.
As the industry becomes more dominated by large global institutional flows, Asian managers now have play on a global stage. Relatively few are positioned for this.