Whither Asia's hedge funds

Jackson Chan is with Sail Advisors Limited (Sail), a subsidiary of Search Investment Group, an alternative asset management firm based in Hong Kong.

On November 29 Campden Publishing will host a group of 12 hedge fund managers and private investors at its Asian Hedge Fund and Boutique Managers conference. Jackson Chan of Sail Advisors, a key participant, reports on Asia's hedge fund industry

The Asian hedge fund industry has seen remarkable growth over the past three years. As experienced global hedge fund investors based in Asia, we have observed this growth with much interest. Two years ago, our parent company Search Investment Group felt that the Asian hedge fund industry had come to a stage where there was sufficient size, diversity and talent to form a dedicated Asian fund of hedge funds product. In January 2004 we launched the Pacific Explorer fund. This sits alongside our longstanding Flagship Fund, which has been investing in global hedge funds since the 1990s. The diversity of long/short funds, and the availability of funds involved in other strategies such as event-driven, distressed, convertible arbitrage, credit and macro also enabled us to run a truly diversified Asian portfolio.
 
Industry databases now count around 600 Asian hedge funds managing some $85 billion in assets. Asset-wise this is a more than fourfold increase over the past three years. During this period, we have seen an average of 100 new Asian-focused hedge funds launching each year. Yet this can hardly be described as a bubble.

Asian hedge funds still only account for a mere 6% of the global hedge fund universe. With Asia-Pacific contributing 15% of world market capital, it is reasonable to say that Asian hedge funds are playing catch up.

Traditionally, the challenge the Asian hedge fund industry faced was that it was over-populated with long/short equity strategies, typically with a long-biased approach and a focus on fundamental, bottoms-up stock picking. This was partly because most Asian fund managers came from 'long-only' backgrounds. However, it was also a result of regulatory restrictions and a lack of instruments available for shorting, particularly in markets outside of Japan, as well as the high cost of borrowing that made shorting uneconomical. As a result, the average Asian hedge fund had a tough time upholding its mandate of protecting capital by having a hedged portfolio, especially when the region's fickle liquidity-driven markets turned south.
 
Sophistication of products
This has begun to change and the Asian hedge fund industry has rather rapidly gained momentum. While Asia on the whole still has a long way to go to match the sophistication of products available in developed financial markets, movements towards liberalisation in the region's financial markets, as well as creative access products developed by prime brokers, have increased the practicality of shorting stocks and indices. This is particularly true in the case of South Korea, India and Taiwan. Governments in the region have also reshaped their attitudes towards hedge funds looking to set up within their borders, with Singapore as an outstanding example. These are the same funds that were publicly vilified during the 1997 financial crisis.

While equity long/short funds still make up about 60% of the Asian hedge fund universe, there is growing diversity within this strategy, which now includes fundamental, relative value, quantitative and macro-based players, as well as country themed funds.

First Greater China and now South Korea and India-focused funds are increasingly popular. We are also seeing the beginnings of sector-focused funds, including Asian real estate, technology and healthcare funds.

Outside of equity long/short, there is a slowly growing pool of Asian multi-strategy arbitrage, special situations, event-driven, distressed, credit and macro managers. The momentum in the industry is creating a virtuous circle, encouraging high quality individuals from a variety of backgrounds to launch their own funds, including proprietary traders from investment banks, investment bankers, and long-only fund managers from local and foreign fund houses, adding further to the available diversity. Particularly in Japan, the growth in Japanese locals launching hedge fund products has provided a new stimulus to the industry, and a different perspective from Western trained analysts of the Japanese market.
 
Coming of age
We have also seen the first signs that the Asian hedge fund industry is coming of age. On average, Asia's hedge fund boutiques are launching with larger fund sizes as the previous start ups with only $1 million or $2 million of assets is no longer commonplace. The teams are also getting larger with dedicated chief operations officers and risk officers becoming the norm. Another trend is that experienced Asian hedge fund managers have begun to spin off from the funds they trained with to launch their own second-generation hedge funds. We have even seen a few instances of pedigree hedge fund managers in Asia who have open and shut within a few months (if not days) of launching.

As elsewhere in the world, this makes the job of a hedge fund allocator challenging. The capacity issue is compounded in Asia by the fact that the size and liquidity of Asian markets mean that the region's funds tend to be more capacity constrained than their global counterparts.
 
This works to the favour of hedge fund investors based in Asia, who know the region and the players well enough to spot talented and solid hedge fund operations in their early stages. The relatively low barriers to entry of setting up and launching a hedge fund business in Asia means the quality of hedge fund managers in Asia does vary dramatically, and allocators need to be savvy in separating those who have benefited from kind markets, from those who are genuinely delivering absolute returns.
 
Over the past year, the biggest theme playing out in Asia is the arrival of multi-billion dollar global hedge funds. Industry sources estimate that there are currently over 60 global hedge fund players that have opened offices in Asia, or are doing so, with names including the likes of Citadel, Tudor, Och-Ziff, Highbridge and Ritchie. Many have been "trading Asia" for several years through night desks in New York. At the moment, most global hedge funds still trade Asia as part of a global multi-strategy portfolio. However, a few have begun to spin off separate Asian products and we see this as a trend that will continue as other players get more comfortable with their set-ups in the region.

Overall, we see the arrival of the hedge fund heavyweights as positive for the Asian hedge fund industry, although there is likely to be teething problems as Asia adjusts to this overwhelming inflow. However, the arrival of global players will raise the bar for Asian hedge funds and increase the strategy diversity in the industry as well as the degree of professionalism. Still, hiring and finding talent in the region could prove to be the industry's biggest bottleneck. Each of these global players is looking to hire full teams of experienced local talent ranging from portfolio managers and traders to analysts and operations and compliance staff.

While the global players will add liquidity to the market, the sheer weight of money they are looking to deploy will mean that certain trades will become increasingly crowded, and fund managers will have to be smarter and quicker to catch windows of opportunity when they arise. But there is much room for growth in Asia's hedge fund industry.

Positioning our portfolio
Amid fluctuating market conditions, our experience over the past 12 months has been a testament to adaptability and foresight. During the final quarter of 2004 we opted to build a balanced portfolio, based on our cautious outlook on global growth and conservative strategy views. However, we modified our stance as the year progressed, having observed exceptional earnings growth and encouraged by attractive equity valuations. We repositioned the portfolio and deployed assets into equity long/short and event-driven managers. The strategy reallocation proved to be a timely call. In spite of our success, we intend to lower market exposure and portfolio risk in the coming quarter. With several impending risks in the market, we intend to increase exposure to the more neutral multi-strategy and relative value strategies in the hope of dampening volatility.