Hedge funds travel East

Richard Willsher is a freelance journalist specialising in finance.

The Asian markets are driving some of the well-known global hedge fund indices and appear to offer hedge fund investors rich pickings, but is this really the case and how can the investor identify the real performers, asks Richard Willsher

There is no doubt about the Asian growth story. At a September 2005 conference Rodrigo de Rato, managing director of the International Monetary Fund said, "Asia has emerged as an engine of growth in the world economy, accounting for over 30% of world GDP and contributing half of global growth in recent years." This has been reflected in the growth and performance of several Asian equity markets while, at the same time the long-awaited awakening of Japan has so far driven Tokyo's Nikkei index up by 17% since the beginning of this year.
 
The biggest driver of all has been the explosive economic growth of the People's Republic of China, which has sucked in imports and investment from other countries in the region as well as from elsewhere in the world and turned them into massive export revenues. So the obvious question for both institutional and private investors to ask is, how can I benefit from this?
 
There has been a rapid rise in the number of hedge funds pursuing Asian investment strategies. One estimate suggests that these have increased three-fold in the last three years. In addition Asia is now thought to account for around $65 billion of global hedge funds assets.
 
But we shouldn't get carried away. Many of the hedge funds involved are quite small, in dollar terms amounting to only around 6.5% of total hedge fund assets – and Asia, if we include only China, India and Indonesia, is very populous, very diverse and very geographically large area of the world. Hong Kong-based Khiem Do, who runs Baring Asset Management's China Absolute Return Fund, provides some perspective. "Yes, there has been a growth in hedge fund activity in the last two or three years but it is still a very new concept here. Asia still accounts for only a very small proportion of hedge fund assets."

He explains that investors are diversifying their hedge fund exposures, not entirely away from but in addition to their much larger allocations to North America and Europe. He confirms also that most of the exposure is to equities both in the major stock markets such as Hong Kong, Tokyo and Singapore although there has been a good deal of new money flowing into the smaller Philippines, Indonesian, Malaysian and Thai stock markets. This is a view shared by Carl Beckley, Director of Research and Development at FTSE Group who also notes that the strategies being pursued by the new hedge funds are not as diverse as those in the major hedge funds territories in the US and Europe.

Which is not to say that there is no choice in terms of strategy but, for example, some of the Asian stock markets do not permit shorting of stocks, while in others some of the other financial markets derivative products hedge funds may like to utilise are not yet developed. The other side of this coin is that more shallow stock markets may provide levels of volatility which hedge funds may be able to take advantage of. This brings into play the importance of market timing in trading which Citibank and others have noted can be critical in achieving high gains in volatile markets. The same applies to momentum trading, a common hedge fund trading technique to gain advantage from large or least significant share price or index level movements in a particular timeframe.

In one respect, at least, some of the Asian markets may be ahead of the game. Since the disastrous Asian currency crisis of 1997, local regulators such as those in Hong Kong have been concerned about investor protection. Although none have as yet instituted registration arrangements, Hong Kong is leading the way in issuing guidelines on possible requirements for registration and regulation of funds to be offered to private investors.

There has been some bad news as well which may conceivably hasten regulation. In the Singapore market, Aman Capital Management closed its fund in April this year losing investors money due to losses on it derivatives trades. There have been other reports of losses by other hedge funds that have committed substantial funds in the Asian region. Just because the region is economically booming does not mean that everyone makes money regardless of risk.

If that is the health warning then the good news is that some of the emerging market and global equity funds do seem to be producing substantially better returns than some of the US and European funds. Moreover it is the Asian markets that are driving some of the well-known global equity hedge fund indices. But as FTSE's Carl Beckley notes, while there are some Asian funds that have done well there are others that are in negative territory. The problem that faces the private investor, as ever, is in identifying the real performers such is the degree of opacity in the way hedge funds disclose their activities.

So, as usual in any discussion about the attractions of investing with hedge funds it all comes down to choosing the best fund manager with the most effective strategy. Baring Asset Management's Khiem Do's advice is not to over-commit to Asia nor indeed to any other region. He says that the regional growth story is very real, and he should know, his own fund invests in companies whose stocks are listed on Hong Kong, Taiwan, Korean and Australian exchanges but which have strong business connection with the People's Republic. But at the same time he adds that for the time being Asia is for the most part a diversification play for many investors.

In their search for yield against a background of low interest rates and modest stock market returns western investors are bound to be attracted to Asia. So the question is whether the way to get Asian exposure is through a standard and less costly route, such as regulated funds or via an alternative and unregulated hedge fund. Some investors may conclude that they need not face a potential additional operational risk by pursuing the alternative route. It is up to the hedge fund managers to present a convincing case especially given the higher levels of remuneration they are likely to charge. At the same time, for sure, there will be some hedge funds that will produce spectacular results for their clients from the Asian markets – so a route investors should consider.