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Major market characteristics of the fund of funds market
in Asia are:
- It has only been in existence for a couple of years and it
is still very much in its infancy both in absolute terms and
in comparison to the market in the US.
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The number of players in it and its overall size are set to
increase dramatically.
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There are few barriers to entry.
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There are currently no dominant players.
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It is opaque.
Its opacity means that it is difficult to get hold of realistic
and accurate numbers about the market; though we estimate
that Asian investors (including Japan and Australia) have
put about US$45 billion into alternatives. In terms of countries,
that breaks down roughly into South Korea $1-2 billion, Taiwan
$3-4 billion, Hong Kong $6 billion, Australia $2-3 billion
with the balance coming from Japan.
The current investments and players in Asia:
In terms of the type of alternatives that are being bought
perhaps as much as 85% is going into fund of funds products
that have their underlying assets invested in US equities
or comparable US dollar-denominated, US-focused investment
strategies. This figure can be split into branded fund of
funds products sold under the name of a US-based manager such
as Grosvenor or Mesirow, and money which has been accumulated
in Asia and given to a discretionary western-based manager
or consultant to put into a fund of funds strategy on a bespoke
basis.
Of the remaining 15% the vast majority will be investments
in large US-based single-manager hedge funds with track records
of greater than five years and a strategy that is based on
US markets. The amount of money that has come from Asia into
Asia-focused fund of funds or Asia-focused hedge funds is
very small.
The buyers of alternatives in Asia have mainly been the large
Japanese financial institutions such as Sumitomo and Orix.
Other buyers are the big established family offices, private
banks distributing to high-net-worth individuals who qualify
as "accredited" or "professional" investors.
Endowments in the form of organisations such as the Hong Kong
Jockey Club and government 'quangos' responsible for reserves
are also starting to consider alternative investment strategies.
In terms of distribution, some of the bigger names in the
fund of funds world have set up their own marketing offices
in Tokyo. Several of the long-only houses such as AXA and
Schroders are going into marketing alternatives. The Man Group,
which is more a hedge fund than a fund of funds, is said to
have sold up to US$1.5bn of product in Asia so far.
How the money is sourced:
Most of the product is being sourced in the west and sold
via the "accredited investor" route by a variety
of intermediates. It is probably safe to say most of the intermediaries
are western-owned private banks and the bulge bracket investment
banks rather then Asia-based distributors. Many of these intermediaries
are selling their own in-house products but that is not always
the case. It will be interesting to see whether the move to
"open architecture" will accelerate this trend.
There is also a growing group of specialist third-party marketers
who independently represent one or more western fund and market
by traveling the region without actually having an office
or regulated presence in Asia. Asian investors have also given
money to Swiss-based private banks to run alternatives strategies
for them.
Asian investors look for western-based products:
There are several reasons why Asia-based investors have tended
to buy western-based products.
- Diversification. If you have the majority of your assets
in Asia it could be said to make sense to get your alternative
exposure in the West.
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Size of the market. Even at its current size of US $18 billion
the Asia-focused hedge fund industry is a fraction of the
global industry. There just are not enough hedge fund investment
opportunities in Asia with the size and track record that
are required.
- Asian investors are new to hedge funds. Investment to date
has been more dipping a toe into the market to test it out.
Consequently there is preference for tried and tested low-risk
strategies.
But the most pressing reason is that the fund of funds decision-makers
have to be where the hedge fund decision-makers are. To invest
in a hedge fund, fund of funds managers or discretionary managers
have to do extensive due diligence on the managers, their
systems, etc. Even if there was the expertise to evaluate
hedge funds in Tokyo the team would have to spend only a small
proportion of their time in Tokyo as the hedge funds that
they were seeking to evaluate are in London or Mid-town Manhattan.
As long as the demand in Asia is for global fund of funds,
the product will be sourced and managed in the west and sold
in the east.
Problems faced by western distributors:
Bear in mind that distributors of western-based financial
products face several problems in Asia. There are the obvious
issues - such as language problems and the lack of a single
major dominant financial centre. Then there are the more difficult
to appreciate issues - an example being the confusing array
of regulatory guidelines (or in some cases the complete lack
of them). The fact is, that in Asia a lot of financial service
distribution focuses on the strength of personal relationships
rather than the quality of the product. It's also true that
some of the normal business practices used to incentivise
deals might cause a few raised eyebrows in compliance departments
in the west. But perhaps the biggest hurdle is the sheer lack
of knowledge about how alternative investment works and the
benefits thereof. In the west there is a realisation among
the upper end of the investing community of the merits of
diversifying into alternative absolute return-based products.
This message is only just beginning to get through in Asia.
Marketing alternatives in Asia is more educational then selling.
Going forward, the trends we see are:
At present alternatives in Asia is a bit of westerner's game.
Gradually this will change. Already some financial institutions
in Asia are setting up due diligence operations in New York
so they do not have to pay for the expertise of western firms.
At the family office level also families that want to get
a meaningful exposure to alternatives are just setting-up
branch offices in the west.
But the overall dilemma of alternatives in Asia is the western
fund of funds looking at Asia saying that "we have the
product but are not equipped or knowledgeable enough to market
it effectively in Asia," and the Asia-based bank saying
"we cannot create the product (track record, size) but
we could market it."
It seems to us that one of the ways that this will resolve
itself is white labelling and bespoke managed accounts, whereby
a local bank agrees to market a western run fund of funds
or bespoke discretionary portfolio, but markets it under its
own brand name. This allows both sides of the transaction
to focus on their strengths. We see huge potential for this
strategy.
One major issue is the fragmentation of the alternatives
industry. On the mutual fund side, the industry has consolidated
to an extent that it is clear that 80% of the money is being
managed and invested by less than 10 visible global players,
starting with Capital and Fidelity. The long-only industry
took a long time for consolidation to occur with it only really
gathering pace from the mid-1990s onward. With alternatives,
particularly in Asia, it is fair to predict that the number
of players is going to increase - particularly as local financial
institutions enter the fray. Consolidation is several years
away from happening. In many ways alternatives are where the
mutual fund industry was in the early 1980's.
The implications of this are interesting:
As the industry becomes characterised by a very large number
of players with no dominant participants operating a variety
of strategies from a variety of locations its opacity will
continue. There will be no central register of information
on performance and fees.
In such a market it is unlikely that fees will come under
pressure. Indeed the high level of fees on alternatives versus
long-only will attract more entrants into the field. The current
demand for guaranteed products, which carry a very high margin,
is a case in point. Marketing will be more word-of-mouth and
road-show instead of brand name recognition and advertising.
In terms of the potential size of the alternatives market
in the region; Japan has the largest pool of savings in the
world, estimated at around US$20 trillion. Though a lot of
that money is of a different kind than has gone into hedge
funds and alternative strategies in the west (such as endowments
and family offices), it is still a frightening large number.
It is difficult to predict the speed at which Japan's savings
will be funnelled into absolute value strategies. Near zero
interest rates should prove a catalyst but capacity issues,
the government's view on alternatives, and the learning curve
will have an impact. Even so, from a five- or ten-year point
of view this is still a market in its infancy.
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