The global hedge fund industry is currently valued at slightly over US$1.5 trillion, growing five-fold in as many years. With increasing interest from institutional investors such as pension and endowment funds, and a deepening value chain (the emergence of data vendors, fund incubators and third-party marketers catering to hedge fund investor needs), the industry has taken on a more mainstream aspect. This has boosted the pace of new launch activity, and with it, the rate of attrition in the industry.
Hedge funds may close shop for a multitude of reasons both positive (such as takeovers, consolidation/ integration, structural changes, etc) and negative (poor performance, the “bandwagon” effect, etc). The latter case is particularly true of funds launched in emerging markets such as Asia, where the rate of industry growth has far exceeded that in the developed markets.
This write-up seeks to examine these causes of attrition in the Asian hedge fund space as they serve as a good alternative measure of industry growth. The analysis is based on information on close to 1,000 Asian hedge funds (180 of which are now obsolete) listed in the Eurekahedge database.
With assets adding up to less than 10% of the global total, the Asian hedge fund space is still in its fledgling state. Exponential growth in this space (in terms of number of funds as well as total assets) is a more recent phenomenon, with launches in the past three years accounting for over 60% of the current number of Asian funds. At least some of this growth may be attributed to a “bandwagon” effect, associated with increased awareness of opportunities in the region and lowered barriers to entry.
Perhaps telling is the fact that funds that have gone under during the same three-year period also make up over 60% of the total number of obsolete funds in the region. Figure 1 below depicts this rise in the attrition rate in recent years. The figure compares growth and attrition in the broad regional hedge fund industries globally. As is evident, the Asian and European spaces have seen the most launches in recent years, especially in 2004 and 2005, where as start-up activity in North America is on the wane. The number of funds closing shop, on the other hand, is steadily on the rise globally.
Figure 1: New-launch and Close-down Activity in Regional Hedge Funds
To test the hypothesis that this recent rise in attrition is not a case of older funds turning less profitable as they grow bigger, we compared the average age (in months, as at Dec 2006) of all the funds launched each year between 2001 and 2005 (refer Figure 2 below). The figure illustrates another way of looking at attrition in key developed (North America) and emerging (Asia) markets of hedge fund investment.
Figure 2: Average Fund Age by Launch Year of Regional Hedge Funds
If all of the Asian and North American funds launched in each of the five years were to remain operational as of Dec 2006, the difference in average age of each year’s launches should be precisely 12 months. This is depicted in Figure 2 by the Zero-Attrition Line (ZAL) with a uniformly downward-sloping curve. While both North American and Asian funds have downward sloping curves themselves, they are flatter or steeper than the ZAL in places – flatter when later launch years have seen longer-lasting funds, and steeper otherwise.
Looking at the slope for Asian hedge funds, for instance, the average age has dropped markedly between those launched in each of the years 2001, 2002 and 2003, and those launched in 2004 and 2005. Other things being constant, this suggests that Asia-centric funds operating between 2001 and 2003 were better-informed about the markets and hence were early birds. A bigger portion of the funds setting up shop in later years, on the other hand, were more likely to be part of the bandwagon effect.
Another cause of attrition in recent years is poor performance, as illustrated by Figures 3 and 4 below. Hedge funds operating in Japan had a very rough run in 2006 (the Eurekahedge Japan Hedge Fund Index was down 3.8% for the year 2006), as the Japanese markets continued to be a mixed bag through the year, with consumer confidence eluding the markets despite healthy corporate earnings and better housing and industrial production. Furthermore, nearly 90% of the Japan-centric funds are equity long/short funds. This explains the relatively high number of Japan-focused funds and of equity long/short funds that went under in 2006.
Figure 3: Attrition by Geographic Mandate in Asia
Figure 4: Attrition by Strategic Mandate in Asia
1For instance, if ten funds were launched in (Dec) 2004 and 5 of them closed shop in Dec 2005, the average age of the ten funds for the period from Dec 2004 to Dec 2006 would be 18 months.