After the disastrous market conditions in 2000 and the first nine months of 2001 pushed Asian hedge funds down, the last quarter of 2001 proved a nice rebound for the industry. Managers made money throughout the region, from playing the falling yen in Japan (either outright US dollar long or purchasing exporters) and buying bank shares in Korea, to domestic plays in Southeast Asia and Hong Kong/China.

These themes continued to play out in the first quarter of 2002. The seemingly quick resolution to the Afghan military campaign and the perception of a strong rebound for the US economy sent most Asian markets higher throughout the first three months of 2002. As most Asian hedge funds (including Japan) utilise a long biased equity strategy, they capitalised on these rising markets earlier in the year. However, Japanese markets continued to lag Asia-only markets due to the general macro-economic perception that Prime Minister Koizumi had failed in implementing meaningful financial reforms.

Everything changed in Japan in late February when the FSA announced a series of rules limiting the ability of managers to sell short stocks; this created one of the largest short squeezes in the last three years. As the Financial Times and other periodicals have since reported, these efforts by the Japanese regulators were intended to synthetically prop-up the Japanese markets in order for banks to report lower than expected marked to market losses on their equity books. The market rallied 25% by the beginning of March, having fallen close to 10% year to date at the end of February. After initial falls during the month, most Japan-only funds were able to sufficiently cover their shorts, and their longs rose sufficiently that the ABN AMRO Japan Index was up 1.1% in March.

As the first month of spring came, most of the Asian regional indices reached their year to date highs, topped by the KOSPI which hit 937 points on April 18th. Many hedge fund managers increased their positions in domestic plays, specifically in Korea, Hong Kong/China and Thailand. Funds' net exposure remained high in Korea throughout the month, which unfortunately proved disadvantageous for a number of the Asian including Japan funds when the KOSPI fell 11% off its high. The increasing tensions between Pakistan and India also hurt managers who were heavily weighted in Bombay during April and May.

However, May proved the best month overall for Japan-only and Asian including Japan managers. The TOPIX was up 3.51% while the ABN AMRO EurekaHedge Japan Index was up 2.39%, mainly because Japan hedge fund managers having less than 100% exposure to the market. The TOPIX's increase during May was due to three main factors: 1) a general re-weighting to Japan and to a lesser extent Asia from U.S. and European mutual funds; 2) a belief in a cyclical earnings recovery in Japan, and; 3) numerous corporate share buyback announcements.

This was a time when most global economists were predicting a substantial US led global recovery for the second half of the year. This sentiment was further buoyed by the staggering 1Q 2002 US GDP numbers of approximately +6% for the quarter. Hedge Fund managers throughout Asia, in particular in Japan, started to substantially increase both net and gross exposures to the equity markets, shifting their focus away from exporters (the US dollar had already begun to fall), technology and Korean positions towards domestic names in Southeast Asia and financials in Japan. Coming into the month of June, many managers expressed a general sentiment of maximum bullishness and a belief that Asia had finally de-coupled from the Western markets.

Both of the above sentiments proved wrong. Markets fell across the region with the exception of India, where military tensions eased significantly but most Asian managers' exposure to the country was small, hence the rise did not have a major effect on funds' profit and losses. TOPIX was down nearly 9%, the Hang Seng fell 6% and the MSCI Far East Free Index was down over 5%; comparatively, the ABN AMRO EurekaHedge Index was down 2.1%.

What was surprising was that Asian hedge funds did not fall more during the past month. Some Japan only managers did post losses of more than 4% in June, but for the most part managers cut their relatively high May-end net exposures at the beginning of the month, went defensive and were able to ride out the turbulent month with relatively little damage. Macro managers made money on the continual fall in the US dollar and short positions in Japanese telecoms and technology. Equity long/short managers continued to play the themes that worked well in April and May: short expensive large caps in Japan and long mid caps, domestic names in Japan, China and Thailand.

As managers prepared for the second half of the year, the general sense of a strong US and thus Asian export-led recovery has largely dissipated; though most managers are not yet overly pessimistic that they espouse Stephen Roach's double-dip theory on the US economy. Coming into the summer holiday months, there was a general ease among managers that Asia already had its corporate governance crisis five years ago and that the accounting scandals (and a subsequent flight from equities) that are now appearing weekly on the American and European broadsheets will not occur in Asia. The themes of the relative cheapness of Asian equities, foreign re-weighting to the region and local consumption has taken the place of the American spender as the catalyst for Asian markets. So far, this de-coupling light theory has failed to materialise.