It has become apparent in the last few months that Asian focused hedge funds are hot. Sitting in Asia, this is evidenced by the rate at which the more established funds are closing, and the facts that several new funds are being created every week and that a long queue of Asian fund of fund products is in the pipeline. What is not so evident are the underlying causes of this sea change.

Our recent travels have given us some idea of the concerns that are driving this process.
Firstly, there seems to be growing disillusionment with Wall Street and what could be argued is an over-hyped US market. Even the US government is questioning the extent to which vested interests have been influencing stock ratings. Beyond Congress, the concern is probably not so much with what is known but with what lies beneath the surface. If an Enron and an Arthur Andersen can collapse so spectacularly, what else is out there in an economy and financial system stretched by record levels of consumer debt and trade deficits?

Compare this to Japan. It has been nearly 13 years since the Imperial Palace in Tokyo was allegedly worth more than the whole of California. This is a country with problems, admittedly, but at least they are largely out in the open. Perhaps, the bubble to be worried about is in America. The bubble in the Asian stock markets has by most accounts been deflated. Some of the more risk-averse money in the West appears to be taking this view and is moving assets overseas to hedge its bets, and some of that is coming to Asia.

Another factor is that fund of fund managers and family offices are starting to forgive and forget the money that was lost on the first wave of Asian hedge funds. These “shoot the lights out” directional funds, which in retrospect were not really hedge funds at all, left a bitter taste. Those that have survived have mainly morphed into process driven hedge funds that more closely resemble their brethren in the West.

The new generation of Asian hedge funds is much more the classic alpha extractor type than the personality cult of old. They may not outperform in a bull market but they have the risk management techniques in place to avoid large drawdowns, and are better able to produce consistent, positive returns.

There is also a growing feeling that alpha is easier to earn in Asia. Partly, this is due to the relative size of the hedge funds in Asia versus the depth of the underlying markets. There are believed to be some 5,000 hedge funds focusing on the US markets, which account for 50% of global stock market capitalization. In contrast, Japan represents 9% of the world equity market, whereas our research concludes that there are less than 60 hedge funds focusing on the country. It is easy to conclude from this data that mis-pricing has not been arbitraged out of the Asian markets to the extent apparent in the US. Of course, Asia does have constraints on liquidity and shorting potential, but in the liquid markets of Japan, Korea and Taiwan the alpha is plentiful.

To get the sort of returns that the typical pan-Asia long short fund is throwing up today a comparable US fund would have to be geared. In the Asian fund world, gross exposures rarely exceed 100%. Of course, the growing interest in Asian funds is also no doubt motivated by the strong performance of the regional equity markets so far this year.
These are largely anecdotal points but it is this sort of feedback that convinces us that the view from Berkeley Square is looking more and more eastward.