Critical Mass

The Asian hedge fund world has gone from cottage industry to a rapidly maturing, must-have sector for global allocators.

The Asia hedge fund industry is integrating globally. Investors are putting money not just with Asia strategies based in New York and London, but with managers based in the Asia-Pacific region.

"There are now 330 to 350 hedge funds with an Asian strategy, of which 50-60 are of real interest to sophisticated hedge fund allocators," says Peter Douglas of Singapore-based hedge fund consultancy GFIA, in remarks at a recent conference hosted by Terrapinn.

Estimates by industry players put the Asian hedge fund world at around $25 billion in assets last year, and Eurekahedge, a Singapore-based hedge fund consultancy and publisher, calculates that sum hit $35 billion in January. That's not much compared to the global hedge fund universe, which is around the $650 billion mark, but it is growing rapidly. Douglas believes the industry will double in size in the next 12-18 months.

London-based GAM, one of the biggest fund of hedge funds with $13.3 billion of assets under management, is considering placing an analyst in the Pacific region in the next year or so. About 8% of its allocation is to this region. "Before, all the Asian strategies were in New York, London or Tokyo," says Kier Boley, investment manager for GAM's multi-manager fund responsible for the Pacific. "But as local enthusiasm has grown and regulations improved to allow you to manage and market hedge funds, more people have been setting them up in Asia."

Although the funds established in the Asia-Pacific region are primarily focused on equity long/short, there is an increasing number getting into different areas, from global macro to fixed income.

For example, GAM's Pacific portfolio now invests as little as 60% in equity long/short, versus nearly 100% a few years ago. Boley says there is now a greater diversity of entrepreneurs in Singapore, Hong Kong and Tokyo. "We're also looking at China-focused funds in Hong Kong, which is a compelling story," he says.

Singapore in particular is becoming the home to all kinds of strategies, from Korea and Japan funds to convertible arb and bond funds. That partly reflects its good business environment and a recently enthusiastic government, as well as the fact that it has traditionally been a centre for investment banks' bond desks, a recent source of start-ups.

Older and Wiser

Two or three years ago the local hedge fund scene was a cottage industry, but it is maturing - which is critical to win new clients, whose demands have become complex, says Ivo Felder, head of hedge fund investment management at Switzerland-based RMF Investment Management, another of the world's biggest gatekeepers.

Four years ago, the end institutional investor just wanted an absolute return, but today demands risk management, diversification, liquidity, tax efficiency, transparency, and knowledge transfer and training so that they can learn how to run hedge funds themselves, he explains.

Similarly, funds of hedge funds used to be satisfied with a hedge fund's return, risk management and sufficient disclosure, but today demand to understand how managers achieve sustainable alpha, and the big ones like RMF or GAM require a hedge fund have the scale and capacity to take larger investments.

"The biggest issue funds of hedge funds have with Asia-based funds is quality of manager, and capacity - most aren't big enough to accept large cash inflows," says Richard Armstrong, managing director at Eurekahedge.

"Scalability is a challenge," says Felder at RMF, particularly as the fund of hedge funds players grow bigger. "For us, investing in a Thai micro-cap long/short strategy is out of the question."

Asia-based funds are starting to meet these new requirements. More of them are hiring professional COOs, research analysts and traders. They are establishing a controlled risk process, and their capacity is growing. GFIA's Douglas says the typical equity long/short fund in Asia can now handle up to $300 million in assets, up from about $100 million two years ago.

"You now have lots of hedge funds with a three-year track record," says Joanne Murphy, associate director for hedge fund business development in Hong Kong. "Three is the magic number for global allocators."

While all of this is positive, these rosy views must be tempered: they are more forecasts than established fact. For most of the hedge funds based in the region, attracting assets remains hard work.

Perhaps the biggest hurdle for funds based in this region is lack of support from local institutional investors and family offices. In Hong Kong, for example, only two pension funds are known to have experimented with hedge funds (the Jockey Club and the Hospital Authority). In Singapore, the Government Investment Corporation and Temasek have put small amounts toward funds of hedge funds, and are said to be looking at trying a few regional managers directly. But these remain exceptions.

Moreover, even when hedge funds are an acceptable part of family offices or institutions' allocations, as is the case in Australia and increasingly in Japan, most of them put their money with global gatekeepers or strategies based in the US or Europe. (This is beginning to change in Japan; see our August/ September 2003 issue.)

Local hedge fund managers say it's hard to raise money. Audrey Chin, partner at Pacific Asset Management in Singapore, says, "When we started out, we thought being a hedge fund was all about performance. But we couldn't access local investors."

For Asian hedge funds that don't fit the stereotype, it's even harder. Pacific has three funds handling fixed-income, commodity and global macro strategies. "The investors who looked at us didn't want that, or if they did, they'd go to a US manager," Chin says. "They thought someone based in Singapore couldn't run a global macro fund, that we couldn't understand the world. They just wanted Asia equity long/short." Pacific broke through with EIM, another large Swiss fund of hedge funds manager.

Although a number of global allocators are now taking the time to visit the Asia-Pacific region, the onus is on fund managers here to travel. "You have to go to Geneva, Zurich, London and New York, because your clients need your service and support, and they want to see you," says James Loh, managing director at JL Capital in Singapore.

So it's no surprise that the Asian strategies getting the biggest bucks are still those based in the US or UK. For example, London-based Sofaer Global Research, which has $900 million of assets under management, is raising money quickly for Asian strategies. William Bourne, partner, says, "We recently made presentations in New York and got three deals on the spot. This is unheard of in America."

Scott Kalb, principal and co-CEO at Black Arrow Capital, a Greenwich, Connecticut-based hedge fund manager, says, "Asia was once out of favour but US institutions now see it as a selling point." He says his portfolios now have up to 70% of assets invested in Asia Pacific.

For these firms, being located in the West is key. "We need to be close to our clients," says Kalb. Even the big hedge fund managers agree that marketing to Asian institutions is an arduous process; big Japanese investors take an agonisingly slow time to make decisions. The only way to access Asian investment is still via funds of hedge funds.

US and European money is reaching Asia because of the region's growth story, and because regulators in many markets have made it possible to short. This remains a work in progress: India, Malaysia, Korea and Taiwan require shorting via synthetics, which is expensive, and clever tricks such as long/short pair trades are often unworkable.

But Asia's brighter prospects make it a worthwhile investment. "Asia is under-owned, particularly in the US," says Bourne. "It is performing strongly relative to other long/short asset classes."

But this kind of directional money is not sustainable. Asia is hot, so Asian hedge funds are hot. Should the Asia story lose its lustre, this money will go elsewhere. Although more prime brokers, hedge fund administrators, consultants and other support services are cropping up, the region's infrastructure is still inadequate. Most funds based here are too small to accommodate allocators' capacity requirements, or are closed.

Moreover, just as the industry has rapidly expanded in terms of new funds, by the same token it is volatile. GFIA reports that 30 Asia hedge funds have closed so far this year, roughly one per week.

But the mood is upbeat; the sense is that infrastructure, capacity and diversity will grow, preferably to a point where the local industry can stand on its own even if global investors retreat from Asia.

"The European hedge fund scene was tiny in 1998 and it grew to $100 billion," says GAM's Boley. "We see the same signs in Asia: acceptance by the authorities, investment talent moving in from the long-only world, and market opportunities."