I have just returned to live and work in Hong Kong at the end of January after 18 months away labouring in the hedge fund industry in New York. Much has changed in the Asian hedge fund world in that time (not all for the better) and my period abroad has afforded me some perspective on our fledgling Asian alternatives industry.
As always the problem in running a business in Asia is one of timing. The increasing size, complexity, institutionalisation, regulation and importance of hedge funds in the US and in Europe is a trend that is irreversible. Asset management in the old world has changed for ever.
Asia, however, lags well behind. The pace of change here is all that needs to be debated, not its direction and consequences. The shape of our future industry will resemble that which we can already see in the western world.
The US and European industries dwarf Asia; up to about 15 times the size by most estimates (assuming Asia has about US$100bn (€133bn) of hedge fund and fund of funds assets). However, the pace of change in Asia comfortably exceeds that of the rest of the world. The growth rate of our industry runs at over 25% per annum compared to a relatively anaemic 15% elsewhere.
Institutional take-up of alternatives and their acceptance by the leading asset consultants dominates asset gathering in Europe and the US.
Client education is very far advanced and as a result there is a flourishing third-party fund marketing business that exists to match buyers with
Product innovation is being driven by institutional needs for asset liability matching and has led to an explosion of structured product and portable alpha strategies. Most western pension pools are underfunded and this adds drive to the need for innovation. Asia, by contrast, has embryonic pension systems and very little take-up of alternative asset investing outside of the high net worth market (Japan and Australia being partial exceptions). Asset consultants can afford to largely ignore the hedge fund universe and do!
Raising assets for a start-up Asian based fund is very hard work.
Asian family-controlled businesses prefer to invest their financial assets outside of Asia, believing with some justification that they can invest in Asia at least as successfully as any hedge fund manager they have ever met.
There are very few indigenous pools of capital earmarked for Asian managers. This forces our start-ups to market themselves in Europe and in North America. The tyranny of distance works against them. The longer they spend on the road marketing, the less time they are spending running the money. Performance suffers and makes asset raising all the harder, a downward spiral. By contrast, a London or New York-based manager can choose from many different routes to raise assets that are right on their doorsteps.
Asia is still largely an
industry of highly correlated (to each other) long/short equity funds. The deeper, more liquid markets elsewhere have led to a much greater diversification of strategies as has the lower percentage of family owned companies and generally lower levels of government interference in corporate affairs.
Macro, merger arbitrage and
event-driven strategies have flourished in this environment. Asian bond and derivative markets are shallow, those in the west are not and hence multi-strategy, credit and fixed income arbitrage are popular. Asia's contribution to the fixed income space is largely in the world of distressed debt investing, a hangover from the events of the late
Asian hedge fund managers also lack experience. Most hedge funds here are run by first generation hedge fund managers who have never before run this type of fund. They probably come from a buy-side background, have little practical business experience and few contacts in Europe and in the US who can help them raise assets.
They rely almost entirely upon
the capital introduction efforts of their prime brokers. Increasingly in the west new hedge fund start ups are captained by second or third- generation managers who have built up the business experience they need to help get their products away to a flying start.
One of the healthier developments of the last two years has been the influx of US and European established hedge fund groups into Asia.
They have bought talent in with them and they have trained locally as well. The next five years will see rapid growth in second generation Asian businesses spinning off from these parents.
Asia has done incredibly well with all of these drawbacks to build the size of industry that it has done in so relatively short a space of time. However, I do believe that the foundations of our business are still quite shallow. This current cycle has seen a lot of money raised (the pace of this is quickening) in ever larger fund sizes.
I question whether the talent pool is deep enough and the markets broad enough to allow for the scale of investment returns that investors in these larger funds anticipate. I suspect disappointment lies ahead.
or my money I would rather invest with those managers who pursue more modestly sized strategies that they are confident can yield higher returns and that better fit the depth of our public markets.
They may take a little more trouble to find, but they exist and they are worth the effort.
Paul Smith is a director of Asia Alternative Asset Partners. He was formerly managing director of HSBC Alternative Fund