The 2008 edition of the Eurekahedge Asia and Japan Hedge Fund Directory covers over 860 flagship funds and is the epitome of its online counterpart, which covers 1,1501 Asian hedge funds2. Based on this and related information, we currently estimate the total size of the Asian hedge fund universe at US$160 billion as of end-2007, up 21% from our end-2006 estimate of US$132 billion. Judging by this, the performance of the Eurekahedge Asian Hedge Fund Index (19% for 2007 and 12% annualised) and the general growth of the industry over the last decade (see Figure 1), the Asian hedge fund space continues to be on a robust growth curve on both counts – number of funds and size of assets.
In this report, we attempt an in-depth analysis of the trends shaping the aforementioned growth. The write-up is structured into two main sections on the current structure of the industry and on fund performance. The former reviews several of the salient aspects of the Asian hedge fund space (such as age, size, investment style, etc) and how their interplay has impacted fund performance over the years. The latter section, on the other hand, takes a closer look at fund performance itself – at how Asian hedge funds fare against their peers in other regions, against other modes of alternative investment, and lastly in terms of the performance fees they charge.
Size and Age
In one key manifestation of the strong growth seen in the Asian hedge fund universe, average fund size has nearly doubled in the last five years, from US$77 million in 2002 to the current US$140 million. More specifically, while funds with under US$50 million in assets grew over three-fold in terms of number of funds (refer to Figure 2), it is the growing number of funds with sizes between US$50 and 500 million that has helped shore up these averages. Indeed, it would be reasonable to assume that many of the smaller-sized funds of five years ago now populate the US$100 to 500 million size range.
On that note, we put together a grid of average fund performance during the last 12 months (ie performance for the year 2007), with age of the fund on the horizontal axis and size of the fund on the vertical (see Table 1).
Basically, the table gives a snapshot of average 2007 performance for a fund of a particular size and age. The rationale behind using 2007 performance as the comparative measure is that that was the only period of returns that all the funds surveyed would have in common. From an investor’s point of view, this table provides valuable insights about the relationship between fund size and performance. For one, funds tend to start small and grow big. The funds that do start big do their fund-raising on the strength of experienced fund managers; while they do generate superior returns, not all investors can have access to the same. Also, returns in bigger-sized funds tend to diminish during the initial few years of operation and the latter-stage revival in returns tends to be a case of diversified multi-strategy investments.
Assuming the case then of a, say, US$25 million fund that falls into the next bigger size range in each successive year of its operation, an individual investor into this fund can expect to nearly double his/her investment in the first three years of the fund’s life, on average (with returns of 11%, 36% and 24% in the first three years, respectively). As returns wane in later years, he or she could either repeat the process with another newly launched small-sized fund or adopt a different permutation from the table below.
Table 1: Comparative Performance by Age and Size of Asian Hedge Funds
Strategy, Geographic Mandate and Manager Location
In this section, we review the current make-up of the Asian hedge fund industry in terms of investment strategy employed, region invested in or the country that a fund manager is based out of. Each of these choices shapes the nature of returns that a fund can expect to generate. For instance, previous research on Japan-investing hedge funds in the Eurekahedge databases uncovered an advantage to being located in Japan as opposed to, say, the UK. To that end, this section reviews the strategies, regions and locations that currently make up the Asian hedge fund space, and identifies which has seen the most growth in recent years.
Also of interest is the way each of these variables interacts with the others in generating a particular type of return. This is dealt with in the sub-section on ‘performance’ by comparing the regions and locations that proved the most profitable, on average, for a particular strategy over the last 12 months.
Over the year 2007, the distribution of assets among various strategies (Figure 3) has remained largely unchanged from 2006 figures, with assets in long/short and multi-strategy funds still making up for almost 75% of total industry assets. That said, the market shares of other strategies are also gradually growing, most notably opportunistic strategies, as is evident from the graph in Figure 6.
In terms of investment regions, however, the shares of funds with a broad global mandate have slipped (as funds increasingly choose to focus on specific regions and/or economies), and so have those of Japan-focused funds (the markets had a terrible run in 2007; the Eurekahedge Japan Hedge Fund Index returned a negative 1.3% for the year, and had a second consecutive negative year). On the flip side, Asia ex-Japan funds in general, and India- and China-focused funds in particular, grew in size.
Figure 3: Breakdown of Industry AuM by Strategy
Figure 4: Breakdown of Industry AuM by Geography
Figure 5: Top Ten Manager Locations for Asian Hedge Funds
In terms of manager location too, there has been a shuffling of market shares. Switzerland and Norway are gaining ground over the UK as key European locations for Asia-focused managers. On the other hand, among Asian locations, Singapore and Hong Kong, poised to ride the booming markets in India and China, have managed to increase their market shares with respect to Japan and Australia.
Elaborating on the growth themes hinted at in the previous section, Figures 6 and 7 chart the strategic and geographic constitution of the Asian hedge fund universe (by number of funds) respectively over the past three years.
As is evident from Figure 6, long/short equities has remained the dominant strategy among Asian hedge funds (making up the remainder of the 100% each year), given strongly bullish trends in the region’s equity markets for the better part of 2007. Similar is the case with multi-strategy funds. On the other hand, arbitrage and event-driven funds have gradually increased in number, broadly owing to high activity levels in the M&A space during the first half of 2007 and rising volatility during the second half. Similarly, in Figure 7, India-, China- and Korea-focused funds were on the rise while the number of Japan-investing funds declined, over the past three years.
Figure 6: Change in Strategic Mix of Total Fund Population
Figure 7: Change in Geographic Mix of Total Fund Population
The broad growth trends seen in the previous two sections do not fully explain the actual 2007 performance of various Asian strategies investing in specific regions or based out of specific locations. These performance comparisons are fleshed out in Tables 2 and 3 below.
Table 2: Comparative (2007) Performance by Strategy and Region of Asian Hedge Funds
Setting aside the usual suspects among the best-performing funds, ie funds investing in Greater China, India and Emerging Asia in general, or funds located in China, Hong Kong, Singapore etc, these tables have other interesting themes to outline. For instance, while Japan-investing funds have turned in some of the worst returns for 2007 on average, Japan-investing event-driven funds have done exceptionally well (33.3%). Likewise, Singapore-based funds exploring equity opportunities in the India (82%) and Greater China (60%) markets posted the best returns in 2007 by a wide margin.
Table 3: Comparative (2007) Performance by Strategy and Manager Location of Asian Hedge Funds
This sets the tone for the peer group analysis in the following section, as we look at the average performance of Asian hedge funds over the last three years in comparison with other regional hedge funds on the one hand, and other modes of alternative investment in Asia on the other. This is followed by a concluding sub-section on performance within the Asian hedge fund space.
Asia vs Rest of the World
Having examined the various endogenous factors affecting hedge fund returns in Asia, this section asks the next logical question of whether hedge fund investments in Asia are better than those in other regional markets in North America, Europe and Latin America.
To answer this question, we compared the average returns (risk-adjusted and otherwise) for each of the broad regional hedge fund mandates over the past 36 months. This is depicted graphically in Figure 8. The broad conclusion is that investments in Asian hedge funds posted superior gains as compared to those in their developed market peers – an Asian hedge fund, on average, generated returns (risk-adjusted or otherwise) of between two and three times those in any of the other mandates compared.
On the whole, however, the quality of returns is the highest in Latin American funds with not only mean returns at 18% but also a return-to-risk ratio of over three times. However, given the economic uncertainty surrounding recent political events in Latin America, we expect the demand for Asian hedge fund investments to continue at its current pace.
Figure 8: Risk-adjusted Returns across Regional Mandates
Hedge Funds vs Other Alternatives
Having established that Asian markets are, on average, conducive for superior hedge fund returns, it remains to be seen whether better returns can be sought from other modes of alternative investment in Asia. In other words, assuming ready investor access to all three modes of investment, is it the region or the way one invests in the region that has a bearing on returns obtained?
To answer this question, we carried out a comparative analysis of average past 36 months’ returns similar to the one detailed in the previous section, among Asian hedge funds, Asian (long-only) absolute return funds and Asian funds of funds3, as represented graphically in Figure 9.
Evaluated purely on absolute performance, long-only funds were the investment vehicle of choice in Asia for the better part of the past three years, with mean returns at an impressive 20%. But on a risk-adjusted basis, Asian hedge funds proved to be marginally better. Furthermore, long-only funds benefited from largely bullish trends during the period under consideration, and have a wider, ie less consistent, dispersion of returns.
Asian funds of funds too have their merits, offering a much tighter spread of returns than the other two, and indeed better bottom-quartile returns than Asian hedge funds – an investor investing into a randomly selected Asian fund of funds is ensured returns of 10% or more 75% of the time, whereas the probability of similar returns with a similarly selected Asian hedge fund or long-only fund is lesser.
Figure 9: Mean and Quartile Returns across Asian Alternative Investment Vehicles
Of course, in reality, the choice of investment vehicle boils down to their accessibility (especially the better-performing ones) to investors. This and the following section are merely exercises in testing whether, on average, hedge funds offer better quality of returns.
Asian Hedge Funds
This section takes up a more detailed analysis of performance in the Asian hedge fund space, starting with a quarter-wise distribution of fund returns by quartile (Figure 10). This is to illustrate the effect on fund performance of deteriorating market conditions during the latter half of 2007. The overall trend is one of steadily declining gains during the last three quarters of the year, both in Emerging Asia as well as Japan. After registering mean returns close to or exceeding 8% each during the second and third quarters, at least 25% of the funds allocating to Asia ex-Japan were in negative territory during 4Q2007. Japan-focused funds had a poorer showing, with only the top-quartile funds managing to remain in positive territory during the same period. Again, this was largely owing to the spillover from trouble in the US housing and subprime markets, and the ensuing credit tightening across global markets.
Figure 10: Quarter-wise Dispersion of (2007) Returns
That said, the superior gains during the first two and three quarters of the year have been able to withstand latter-quarter losses and overall fund performance has been one of the best in 2007. As has been hinted at in earlier sections, the best returns during the year came from emerging Asian managers in general and single-country focused managers in particular (see Figure 11).
In terms of strategic mandates, however, returns during the past year were distributed more evenly, with opportunistic and directional equity funds posting impressive gains during the first half of the year, and arbitrage, relative value and CTA funds catching up during the latter half. As a result, the best performing funds on the year were multi-strategy funds, with annual returns at a robust 27%).
Figure 12: Distribution of Returns across Asian Strategic Mandates
As we go into 2008, the first two months have been characterised by turbulent underlying markets. The month of January saw some of the worst monthly losses in several years, as hedge funds across the board had to contend with margin calls amid steep declines in global equities. Managers allocating to emerging Asia were among the worst-hit (the composite Eurekahedge Hedge Fund Index lost 2.6% in January 2008, while its Asian component shed 5.7%). Despite concerns surrounding a global economic slowdown (and fears of a recession in the US) weighing on most regional markets, bullish trends in the commodity markets in February lent support to equity prices in some of the emerging Asian markets, and managers in the region have been able to recover some of the lost ground (1.5%) from the previous month.
Going into March, the markets continue to be characterised by volatility, with many major markets often exhibiting daily movements of about (or even in excess of) 1%. The continued downward trend in the US dollar coupled with a higher-than-expected rise in inflation and other negative economic data emanating from the US (such as poor jobs numbers and further declines in home prices, for instance) have also been weighing on the markets, resulting in heightened concerns about the possibility of a recession in the US.
On the other hand, the Federal Reserve needs to respond to the worrisome rise in inflation, especially after its aggressive rate cuts in January and again in March, to the current low of 2.25%. That said, the Fed’s actions to date as well as the upcoming US government plan to revamp the regulatory structure of the financial system, are positive signals for market stability in the long run.
These are interesting times for hedge funds, as the current market environment is rich with opportunities. As of end-February, with crude oil and precious metals around their record highs, the dollar close to its all-time low against some major currencies, equity valuations relatively low across the board, and a decidedly more volatile trading environment, managers could profit on both the long and short books. After a sizeable period of steadily rising markets and long-biased allocations, current market conditions could help illustrate the alpha-generation potential of hedge fund strategies in the region.
1 Including 158 obsolete funds and funds of multiple share classes.
2funds with an investment mandate in Asia and/or with managers located in Asia.
3 615 hedge funds, 93 absolute return funds and 74 funds of funds, all Asia-investing, were surveyed.