|
2004 performance
While the year in 2004 saw respectable gains
for many managers, it was not the stellar
year which we saw in 2003. The ABN Eurekahedge
Asian Hedge Fund Index gained almost 9%
through the year, falling short of the 27%
gains in the previous year. In contrast,
the MSCI AC Asia Pacific Free Index and
the MSCI AC Asia Pac. Free Index ex Japan
rose by 16% and 19% respectively over the
year.
Index performance
|
Asian indices
|
2004 return
|
2003 return
|
Annualised return
|
Sharpe ratio
|
Annualised SD
|
|
Eurekahedge Asian
Hedge Fund Index
|
8.79
|
26.57
|
11.02
|
1.89
|
5.84
|
|
Eurekahedge Japan
Hedge Fund Index
|
9.02
|
18.67
|
9.42
|
1.50
|
6.29
|
|
Eurekahedge Asia
ex Japan Hedge Fund Index
|
9.18
|
34.18
|
11.84
|
1.32
|
8.96
|
Most managers in the hedge fund industry found
2004 to be a difficult year, especially in
comparison to 2003's impressive gains, and
cited decreased volatility and conservative
net positioning due to a climate of uncertainty
as the main causes. Traditionally, returns
of hedge funds focusing on Asia tend to have
greater market correlation than their counterparts
based in European or American markets. This
is due to the strong presence of long/short
equity funds in Asia, most which tend to hold
net long positions.
What also made the year difficult for hedge
funds was that markets moved only modestly
in the first half of the year. Notably, performances
took a dive in May and June amidst concerns
of a hard landing in China and interest rates
rising faster than expected in the US. Markets
turned around and began to move more dramatically
when oil prices jumped and the dollar went
into a range-breaking decline. Many funds,
particularly directional macro strategies,
made a good profit in November. However, December
proved to be unexpectedly rough, as the dollar
rallied and crude prices sagged, catching
many managers off guard.
In terms of investment mandates, Taiwan-only
funds reported a 9% return, and is one of
three regional mandates (the other two being
Australia/New Zealand and Korea) to record
a positive gain over the preceding year. Nevertheless,
it is worth noting that Taiwan does not attract
many funds as a sole focus of investment.
Taiwan-focused funds make up less than 1%
of the total Asia Pacific-focused funds, reflecting
in some part the traditional reluctance on
the part of Taiwanese institutional investors
to diversify into hedge funds, its reliance
on a tech industry that is hard to call and
an overall economic situation blighted by
political uncertainty.
Performance by
regions
|
Investment mandate
|
2004 return |
2003 return |
Annualised return
|
Sharpe ratio |
Annualised SD |
|
Asia ex-Japan |
5.95 |
35.28 |
15.23 |
1.58 |
12.93 |
|
Asia incl Japan |
9.49 |
29.28 |
15.03 |
1.30 |
12.24 |
|
Australia / New
Zealand |
16.13 |
15.94 |
17.03 |
1.74 |
7.61 |
|
Emerging Markets |
10.03 |
37.64 |
15.89 |
1.71 |
13.99 |
|
Global |
7.04 |
22.31 |
15.04 |
1.36 |
13.50 |
|
Greater China |
1.88 |
36.39 |
12.60 |
1.85 |
11.61 |
|
India |
25.84 |
48.08 |
59.25 |
3.14 |
21.02 |
|
Japan only |
9.95 |
17.99 |
11.74 |
0.96 |
10.98 |
|
Korea |
12.10 |
10.25 |
16.47 |
1.39 |
17.90 |
|
Taiwan |
9.02 |
2.30 |
5.66 |
0.54 |
11.99 |
India continued to be a lucrative region for
hedge fund managers, reporting the highest
annualised returns since inception for the
universe of India-only strategies at 59.25%.
In spite of the higher level of volatility
in these markets, in comparison to the rest
of the universe, the Sharpe ratio for the
region was the highest as well at 3.14, largely
because of these exceptional returns. This
was due in large part to the impressive rally
which Indian stock markets had seen over the
period.
The Greater China region saw a 1.88% return
in 2004, in a steep decline from 2003's 36.39%
gains, as investors remained wary of government
measures to slow down the Chinese economy,
as well as on corporate governance issues.
Strategy-wise, event-driven funds saw the
highest annualised return since inception,
recording a 20.71% return, closely followed
by distressed debt strategies, which recorded
a 19.6% annualised return. This was brought
about by the increase in global corporate
activity, which fed through to the region,
and created more opportunities for these funds
in terms of merger and acquisition activity,
as well as debt restructurings.
Performance by
strategy
|
Strategy |
2004 return |
2003 return |
Annualised return |
Sharpe ratio |
Annualised SD |
|
Convertible Arbitrage
|
2.38 |
8.84 |
4.45 |
0.77 |
3.70 |
|
CTA |
-1.37 |
10.52 |
10.53 |
0.56 |
12.64 |
|
Distressed Debt
|
17.08 |
28.18 |
19.60 |
3.24 |
6.67 |
|
Event Driven |
19.39 |
12.72 |
20.71 |
2.68 |
6.73 |
|
Fixed Income |
9.74 |
16.29 |
12.65 |
4.27 |
6.85 |
|
Long / Short Equities |
9.82 |
28.76 |
16.81 |
1.35 |
12.65 |
|
Macro |
2.47 |
29.34 |
10.86 |
0.70 |
18.96 |
|
Multi-Strategy |
11.18 |
21.15 |
13.45 |
1.19 |
10.53 |
|
Relative Value
|
3.61 |
17.19 |
7.46 |
0.89 |
11.25 |
Fixed income strategies saw a reasonable performance
in 2004, with 9.74% returns though this was
much lower than the 16.29% recorded in 2003.
The Sharpe ratio for fixed income strategies
is the highest among all strategies at 4.27,
driven more by exceptionally low volatility
than returns.
CTAs posted a bad year in 2004, averaging
-1.37% returns over the period. Reasons for
the poor performance across the CTA universe
vary. Some funds had benefited from the strong
Chinese demand for metals while others suffered,
and a similar scenario was played out in the
oil and rates markets, depending on the CTA
model. In addition whipsawing markets in April/May/June
hurt directional, long-term traders while
short-term traders were hurt by the low volatility.
It is worth noting that the Asian large-cap
funds (funds with more than US$250 million
AUM) seem to lag their small- and mid-cap
peers in the region, recording the lowest
annualised returns at 9.89%, in comparison
to 11.29% and 10.49% respectively. However
looking at the returns generated in 2003 and
2004, it seems to suggest that the mid-cap
funds were the laggards in the universe instead.
Mid-caps funds, being more risk averse, did
not take as large a position in the bull market
to ensure greater returns, as did large-cap
funds which are more confident, and small-cap
funds which have more to prove.
Performance by
assets under management
|
Asian indices
|
2004 return |
2003 return |
Annualised return |
Sharpe ratio
|
Annualised SD |
|
Eurekahedge Asian
Small Cap Hedge Fund Index |
9.10 |
28.21 |
11.29 |
1.71 |
6.59 |
|
Eurekahedge Asian
Mid Cap Hedge Fund Index |
7.27 |
22.04 |
10.49 |
2.01 |
5.21 |
|
Eurekahedge Asian
Large Cap Hedge Fund Index |
11.25 |
28.13 |
9.89 |
1.67 |
5.92 |
The outperformance of large-cap funds over
their smaller peers in the last two years
goes some way to dispel the commonly-held
misconception that (a) smaller funds outperform
larger funds and (b) there is a lack of capacity
in the markets for larger funds.
Nonetheless, hedge funds did still remain
popular in 2004, drawing investors not just
from traditional clients like funds of funds,
but also from new clients like pension funds,
eager to make up for losses suffered from
traditional investments following the dot-com
meltdown in the late 1990s.
Going forward, it is expected that demand
for hedge funds should remain healthy in 2005,
as US-based investors begin to increase their
allocation to the region, though the new SEC
registration rules for hedge funds with at
least 15 US-based investors may dampen the
desire for Asian hedge funds to accept many
US-based allocators. Observers point to the
entry of the Singapore government investment
firm, Temasek Holdings, into the hedge fund
market last November when it launched its
US$300 million Fullerton Short Term Interest
Rate Fund, as an example of the increasingly
mainstream flavour of the alternative investment
route in Asia. Investors in the fund include
government-linked companies under the Temasek
umbrella, as well Temasek itself, which generates
US$1.4 billion a year in dividends. At the
end of January this year, the state investment
giant also revealed further plans to launch
a fund of hedge funds, focusing on investment
in Asia-Pacific markets.
Industry growth
Asia Pacific markets make up 15% of the world's
market capitalisation, but Asia-strategy hedge
funds represent only 5% of the world's hedge
funds by assets. The robust growth seen over
the past three years is a definite indicator
that this disconnect is continuing to close.
Asia's core attraction to global asset allocators
is that it possesses some world class managers
who are close to the ground, with the real-time
flexibility and insight that intuitively entails,
and who typically still have capacity, unlike
in more developed markets.
Growth of the Asian industry was fairly flat
from inception in the late 1980s. The last
decade, however, saw a steady rise in the
number of funds and assets with rapid acceleration
in the last four years from 2001 to 2004 and
no signs of abating in the early part of 2005.
Figures from the Asian hedge fund industry
continue to indicate strong growth, with 100
new funds launched in 2004. The number of
Asian funds is expected to rise, by our estimates,
to at least 600 by the end of 2005.
Growth in single manager
Asian strategy hedge funds
This growth in creation of new funds is aided
by the liberalisation of short-selling rules
in certain markets in the region, improved
liquidity and the entry of more diverse players
and strategies. Proactive governments such
as Singapore, have further eased the start-up
process for many funds. One such move as announced
in the 2005 Budget, is the introduction by
the Monetary Authority of Singapore of a 12-month
window period for approved start-up fund managers
to meet the general rules relating to tax
exemption of offshore domiciled funds. Details
on this are due to be released by end of March
2005. In Hong Kong, while full licenses are
still required for fund management and the
general period of application advised by the
SFC is 15 weeks, there have been moves towards
reducing this process, as well as recent reminders
that temporary licenses can still be processed
allowing an early foothold.
Number of new
funds launched
Asset growth figures also paint an encouraging
picture, surging by 51% in the year. For 2005,
we expect assets to grow to US$85 billion
through a combination of asset flows and performance,
up 42% from 2004's total assets of US$60 billion.
Notwithstanding, we believe these estimates
may be conservative.
Growth of the industry
|
Year |
Size of industry
(US$m) |
Increase |
|
1995 |
4,299 |
|
|
1996 |
5,525 |
29% |
|
1997 |
9,117 |
65% |
|
1998 |
10,983 |
20% |
|
1999 |
13,036 |
19% |
|
2000 |
16,398 |
26% |
|
2001 |
17,916 |
9% |
|
2002 |
20,668 |
15% |
|
2003 |
39,511 |
91% |
|
2004 |
59,666 |
51% |
|
2005(E) |
85,000 |
42% |
In addition, there has been a shift in the
location which these assets are managed from,
as assets managed from outside the region
fell steadily to 38% of the total, compared
with 50% two years ago. This has led to a
dramatic increase in the number of Asia-based
funds from 150 in at the end of 2002 to almost
300 as at December 2004. These figures reflect
the growing importance of the Asian investor,
as well as increasingly crowded markets in
the US and Europe, which is prompting some
managers to seek superior performance elsewhere.
Fears of a bubble in the industry however,
are unfounded from an Asian perspective as
the region is essentially catching up with
the rest of the world. The number of funds
and assets deployed also remain relatively
small in the global context of more than 7,000
distinct funds worldwide and assets
of more than US$1 trillion under management
from single-fund managers alone. While the
rate of growth of the industry has slowed
from the explosive 50% increase in numbers
we saw in 2003, to around 25% growth in 2004,
we believe that this is indicative of a rapidly
maturing industry, and that there remains
scope for further development in the Asian
industry.
Changes in location primacy
Singapore has emerged as the top choice for
Asian hedge fund start-ups in the region with
19 launches in 2004. This is while Australia
has fallen from the top of the league with
only 13 launches in 2004 as compared to 27
in the previous year. On the other hand, UK
retained its popularity for start-ups, reflecting
the continuing importance of European institutional
investors, and the close relation between
investor proximity and capital introduction
for many funds. Asian hedge funds gained close
to 40% of their capital from Swiss investors
in 2004. This was followed closely by the
UK and US with 30% and 20% respectively, but
Asia-Pacific investors continued to lag behind
in race of capital flow into the region's
hedge funds, being responsible for one tenth
of flows, including those from Japan.
New funds launched
by (major) regions 1
|
Location |
2003 launches |
2004 launches |
% change |
Total number of
funds |
|
Australia |
27 |
13 |
-51.9 |
85 |
|
China |
0 |
2 |
n/a |
4 |
|
Hong Kong |
11 |
13 |
18.0 |
87 |
|
India |
0 |
1 |
n/a |
2 |
|
Japan |
15 |
9 |
-40.0 |
52 |
|
Korea |
2 |
0 |
-100.0 |
3 |
|
Malaysia |
4 |
0 |
-100.0 |
6 |
|
New Zealand |
0 |
1 |
n/a |
2 |
|
Singapore |
15 |
19 |
26.7 |
61 |
|
Taiwan |
1 |
1 |
0.0 |
4 |
|
United Kingdom
|
24 |
24 |
0.0 |
128 |
|
United States |
24 |
14 |
-41.6 |
99 |
Hong Kong's attractiveness versus Singapore
as a location for start-up funds in Asia has
steadily eroded, as evidenced from the 13
funds launched there in 2004 in comparison
to 19 in the city state, up 27% rise from
the previous year. Singapore accounted for
20% of the new launches in the Asia-Pacific
region in 2004, as opposed to 13% for Hong
Kong. However, in terms of total AUM, Hong
Kong remains well ahead of Singapore, at around
US$9.3 billion to Singapore's US$2.8 billion,
out of an Asia-Pacific total of US$60 billion.
The doubling of Singapore's share of the region's
start-ups from 12% in 2003 to 20% in 2004
has much to do with active measures that the
Monetary Authority of Singapore has put in
place to woo prime brokers and other builders
of market infrastructure. For instance, since
2002, the Securities and Futures Act and the
Financial Advisers Act have introduced significant
changes to the operations of the financial
system. This included opening up the distribution
market for offshore funds, allowing direct
access to the retail public in Singapore;
as well as the lowering of investment limits
for retail hedge funds so as to introduce
an alternative investment vehicle for retail
investors. In addition, Singapore has further
clarified its equities clearing laws (to the
benefit of long/short equity funds) and has
simplified its tax exemption laws for hedge
fund managers.
In contrast, Hong Kong's continued uncertainty
over its offshore funds taxation policy has
served to deter potential managers from setting
up operations in the SAR. In a bid to retain
Hong Kong's position as an international financial
centre for the region, the Financial Services
and Treasury Bureau issued its second consultation
paper on the exemption of profit tax for non-Hong
Kong residents, on gains made from offshore
funds at the end of last year. Hong Kong has
also introduced a temporary hedge fund license
for existing hedge fund managers based outside
of Hong Kong.
That said, it is not an entirely smooth ride
for managers trying to start out in Singapore,
and there remain two issues for fund managers
debating the merits of setting up in the Republic
- that of the tax structure and regulations.
Foreign funds need to have at least 80% of
their investments from overseas in order to
qualify for tax exemption, and this is a difficult
requirement for many start-up managers to
meet. Some managers also feel that a 10% tax
rate on fund management fees may be too high
and are looking to have it halved to 5% instead,
to attract more onshore fund managers.
Overall, however, the biggest issue for many
managers is that of registration and this
has proved to work in Singapore's favour.
In both Hong Kong and Singapore, managers
are required to register as investment advisors
before they are allowed to trade securities.
However, there remains a startling discrepancy
in processing time, particularly given Hong
Kong's consistently high ranking as the world's
most competitive economy. While it takes a
couple of weeks to register a start-up in
Singapore; it takes several months in Hong
Kong. This is a big issue for Japan-located
hedge funds as they need to have their trading
offshore and more and more are having their
trading set up in Singapore than in Hong Kong.
This lag in processing times has also much
to do with the recent arrival of big American
funds such as Tudor, Everest and more recently,
Moon Capital in Singapore, instead of in Hong
Kong.
The rise in Singapore's fortunes as a hub
for Asian hedge fund managers was mirrored
in reverse by the decline in Australia's share
of the region's start-up market, which almost
halved from 22% of the market in 2003 to 13%
in 2004. This reflects the difficulty funds
have in raising new capital, given the continent's
time difference to key investors in Europe
and the US. Many investors find the trip down
under taxing in terms of resources. The ease
of operating from competing hubs like Singapore
and Hong Kong, in terms of both lifestyle
and logistics, has thus made Australia less
attractive as a start-up location. In addition,
many of the hedge funds in Australia are still
denominated in Australian dollars; only a
few have offshore money.
Strategy
There remains a strong predilection among
Asian hedge funds for long/short equity strategies,
with almost 60% of the universe falling under
this category in 2004. This reflects the earlier
stages of the industry, when it was dominated
by fundamentally driven, long-biased equity
managers, who aggressively sought high returns
from equity implementation of macro-type thematic
bets.
New funds launched
by strategy
|
Strategy |
2003 |
2004 |
% change |
% of total universe |
|
Convertible Arbitrage
|
2 |
1 |
-50.0 |
1.7 |
|
CTA |
7 |
4 |
-42.9 |
5.4 |
|
Distressed Debt
|
2 |
2 |
0.0 |
3.0 |
|
Event Driven |
5 |
3 |
-40.0 |
2.2 |
|
Fixed Income |
3 |
2 |
-33.3 |
2.2 |
|
Long / Short Equities
|
75 |
61 |
-18.7 |
59.5 |
|
Macro |
9 |
6 |
-33.3 |
6.7 |
|
Multi-Strategy |
18 |
10 |
-44.4 |
13.9 |
|
Other |
2 |
1 |
-50.0 |
0.9 |
|
Relative Value |
3 |
3 |
0.0 |
4.6 |
Looking at new launches, it was surprising
that not as many directional macro funds were
launched considering the exceptional returns
of this strategy in 2003. The number of multi-strategy
funds launched in 2004 was also lower than
that launched in 2003. Predominantly the domain
of ex-prop desk traders, this perhaps suggests
that less of these traders left their investment
banking jobs after 2003 to launch multi-strategy
Asian hedge funds; presumably because of the
fruits enjoyed in the buoyant Asian markets
in 2003.
At only 2% of the universe, the number of
convertible bond arbitrage hedge funds remains
small in Asia. This is as opposed to Europe
where these comprise almost 7% of European
hedge funds due to a much larger number of
convertible bond issues in this region.
Recent market information suggests that start-up
funds are becoming increasingly less focused
on a narrow range of investment strategies.
Traditionally, Japanese and pan Asian long/short
funds have accounted for the bulk of start-ups.
However, it is expected that the domination
of long/short strategies will diminish as
the number of proprietary traders launching
macro funds, commodity trading pools and multi-strategy
arbitrage funds increases.
Asset
flow comparison2
|
Strategy |
2003 |
2004 |
Average size
(US$m) |
|
Convertible Arbitrage
|
0% |
0% |
41 |
|
CTA |
14% |
14% |
109 |
|
Distressed Debt
|
7% |
5% |
235 |
|
Event Driven |
2% |
3% |
160 |
|
Fixed Income |
2% |
2% |
92 |
|
Long / Short Equities
|
62% |
59% |
147 |
|
Macro |
1% |
2% |
50 |
|
Multi-Strategy
|
7% |
10% |
104 |
|
Other |
0% |
0% |
37 |
|
Relative Value
|
4% |
5% |
81 |
In terms of average size of the respective
strategies, distressed debt funds lead the
pack averaging US$235m, attributable mainly
to four large funds with successful track
records dating back to the late 1990s.
The impressive performance of distressed debt
and event-driven strategies in the last two
years means these approaches are also likely
to be considered for new Asian hedge funds.
The decline in new launches in the hedge fund
universe across most categories, except that
of distressed debt, should not distract from
the fact that the Asian industry has grown
almost 4,400% since ten years ago, and is
now reaching a maturing pace of growth.
Regional mandate, asset flows and average
asset size
The number of new launches focusing on Asia
including Japan, saw a 57% increase from 14
to 22 in 2004. This was while the Japan-only
strategies saw a sharp decrease in interest
from start-ups, experiencing a decline of
almost 50% through the year from 38 to 20
new launches, perhaps reflecting investors'
growing preference for more aggressive emerging
markets strategies.
New
funds launched by regional mandates
|
Regional mandate |
2003 |
2004 |
|
% of total universe |
|
Asia ex-Japan |
11 |
10 |
-9.1 |
12.7 |
|
Asia incl Japan
|
14 |
22 |
57.1 |
18.6 |
|
Australia / New
Zealand |
13 |
5 |
-61.5 |
6.7 |
|
Emerging Markets |
6 |
6 |
0.0 |
6.7 |
|
Global |
28 |
16 |
-42.9 |
19.6 |
|
Greater China |
7 |
9 |
28.6 |
4.8 |
|
India |
4 |
4 |
0.0 |
2.0 |
|
Japan only |
38 |
20 |
-47.4 |
27.0 |
|
Korea |
3 |
0 |
-100.0 |
1.1 |
|
Taiwan |
1 |
1 |
0.0 |
0.7 |
This was in contrast to asset flows, which
saw the strongest flows to Japanese funds,
at 41% of all flows to the region, totalling
almost US$8.2 billion. Asia including Japan
funds saw more than a quarter of the flows
in 2004, while Asia excluding Japan funds
saw a fifth of total flows. While there has
been a slowdown in the growth of the absolute
number of Japan-focused funds, from 50% in
2003 to 17% in 2004, total assets have increased
by almost 82% from the previous year.
Asset flow comparison2
|
Investment region |
2003 |
2004 |
Average size
(US$m) |
|
Asia ex-Japan |
15% |
20% |
131 |
|
Asia incl Japan |
19% |
26% |
168 |
|
Australia / New
Zealand |
4% |
7% |
86 |
|
Emerging Markets
|
7% |
9% |
134 |
|
Global |
22% |
37% |
111 |
|
Greater China |
2% |
2% |
52 |
|
India |
0% |
1% |
55 |
|
Japan only |
24% |
41% |
149 |
|
Korea |
0% |
0% |
27 |
|
Taiwan |
0% |
0% |
19 |
There was also a 60% fall in the number of
new launches of Australia/New Zealand-focused
funds. This was while their share of the asset
flows in the region rose from 4% to 7%.
Average asset size of funds located in Japan
fell by 14% to US$145 million, while those
of funds located in the UK rose by a good
60% to US$157 million, which shows that being
close to dominant investor bases still counts
in terms of attracting assets. The average
size of funds based in Singapore remains the
smallest in the universe at US$46 million,
while those based in Hong Kong and Australia
saw strong increases of 40% and 49% respectively.
US-based funds saw a 6% decrease in average
asset size.
Average asset
size (US$m)
|
Country |
2003 |
2004 |
Increase |
|
United States |
202 |
191 |
-6% |
|
United Kingdom |
98 |
157 |
60% |
|
Japan |
168 |
145 |
-14% |
|
Australia |
77 |
115 |
49% |
|
Hong Kong |
81 |
114 |
40% |
|
Singapore |
36 |
46 |
29% |
Asset flows into Asian hedge funds in 2004
were largely derived from non-Asian investors,
with 40% of investors from Switzerland, 25%
each from the UK and US, and 5% each from
Asia ex-Japan and Japan. However there is
an increasing interest in Asian hedge funds
from US investors, and Japanese institutions
are stepping up allocations to single manager
Asian strategies. There is also an increasing
demand for emerging market hedge funds, particularly
in Asia. The China and India growth stories
are attracting a lot of investor attention
from the US, and the rest of emerging Asia
is firmly on the radar of European investors
looking to diversify portfolios with quality
managers.
Though the number of beneficiaries of the
increased demand remains small - the bulk
of the asset inflows in 2004 went to around
20% of the funds - the large boutique managers
proved to be just as capable of attracting
assets as institutional players.
Prime broker trends
Hedge funds are amongst a bank's best customers,
generating commission revenue for the bank
from the large number of trades they execute
in comparison to traditional long-only managers.
They also utilise a wide variety of services,
from capital introductions to trade settlements
and credit advances, not to mention a whole
range of back-office services and trade ideas.
The balance of power in the battle for prime
brokerage fees has shifted steadily among
the various investment banks over the last
three years in the Asian industry. The market
in Asia is dominated by four banks, covering
77% of the industry.
Prime brokers
by market share
Outlook for Q1 2005 3
Managers are likely to remain cautious in
the new year, seeking to hedge returns rather
than leverage gains from large directional
bets. This is due to decreased visibility
and fears of continued low volatility in
the markets for many managers. While sentiment
and liquidity continue to look supportive,
the overall equity market valuations are
not cheap and speculative flows may leave
abruptly should there be signs of a sustained
dollar rally.
The Australian stock market should continue
to see strong activity, as equity supply
is limited by heavy share repurchases by
corporates and significant takeover activity.
The equity market ended 2004 strongly, aided
by natural resource plays (which Asian hedge
funds were heavily exposed to). It rose
3% in December and moved past 4,000 for
the first time. It was the best performing
market in the region for the year by a significant
margin. Managers expect momentum for the
market to continue positively, driven by
continued upgrades to consensus earnings
forecasts and ongoing strong liquidity.
However, with the risk of a slowdown in
domestic economic activity looming on the
horizon, managers will be paying close attention
to trading updates and outlook comments
during the upcoming reporting period.
Overblown concerns about a Chinese "hard
landing" by many investors have cheapened
the stocks relative to valuation. Investors
are now skittish with the benchmark Shanghai
Composite Index having slid 15% in 2004
- Asia's worst performing in 2004. This
is as Beijing launched a campaign to slow
its overheating economy during the year.
On the flip side, this trend looks likely
to provide hedge fund managers with good
long-side opportunities in China shares,
with the likelihood of Renminbi appreciation
further enhancing those potential returns.
In addition, rough studies of the output
gap suggests over capacity in many industries
like automobiles and steel. This could mean
an upward pressure on prices of coal and
iron ore but downward pressure on finished
goods like steel.
Asian managers did well investing in Hong
Kong property stocks during 2004; the Hang
Seng Property Index was up 23% as compared
to the 13% rise in the Hang Seng Index,
though this was not necessarily always pure
alpha gains as the Hang Seng Index is around
20% property. The other sector which performed
well last year was the Hong Kong retail
market, boosted by an increase in mainland
tourists for the year. Retail bellwethers
like ESpirit and Giordano were the main
beneficiaries.
India was a top performer for the year in
the hedge fund universe, returning annualised
gains of 43.85% in 2004. Managers expect
that the Indian market's recent sell off
should give rise to further buying opportunities
across a diversity of sectors. At the same
time, there are greater opportunities for
individual shorts in India, both factors
serving to enhance prospects in the new
year for equity long/short strategies.
In addition, India has not had an investment
cycle since 1994-1996. Its industries consolidated
during 1997-2002, and balance sheets are
mostly unleveraged. The aggregate bank loan
to deposit ratio is 60%, which notwithstanding
excessive borrowing by the central government,
leaves ample liquidity to supply further
demand for credit.
Valuations today are also reasonable. A
year ago, the Indian market traded 14x forward
earnings whereas today it trades 12x forward.
Using calculations from some funds, assuming
that India can grow earnings by 10%, the
market can rise almost 15% from here without
stretching historical valuation bands. While
India is no more than 5% of a non-Japan
Asian benchmark today, it is expected that
this number will be multiples higher in
three years' time. As such, sentiments remain
positive on the prospects for India in 2005.
On the other hand, Korea remains an ambivalent
play for investors, given the economy's
difficulties and political risks. Some investors
find cheer in the Korean market's valuations,
better capital management, as well as activist
minority shareholders and private equity
holders. They see solid opportunities over
the next 12-18 months in companies which
have global and regional businesses or in
industries at home which have franchise
value and profit-motivated shareholders.
Others however beg to differ, pointing to
the high levels of consumer debt, with 16%
of the working population still credit delinquents
after the credit bubble of 2001-2. Levels
of small enterprise debt also remain high,
and these combined factors could damage
financials by forcing debt write-offs as
a means of alleviating the situation. In
addition, slower China investment demand,
potential Chinese competition in exports
and a stronger Won, add to domestic vulnerability
to external shocks, and opportunities for
strong short selling.
Given the uncertain prospects, it thus seems
likely some managers will avoid taking strong
views in Korea for now. We expect to see
active hedging in these markets at many
funds in the coming months ahead.
Malaysia is likely to allow its currency
to appreciate from the current peg, and
managers are likely to try gaining exposure
there. This appreciation is not expected
to hurt Singapore, which should continue
to offer one of the better risk/rewards
in our region. Meanwhile, the recommendation
to lift a long-standing ban on the practice
of regulated short-selling and securities
borrowing and lending will be positive for
the market.
Taiwan underperformed most of last year,
and some managers might be tempted to gain
exposure to the depressed tech sector, given
its current valuation. Potential improvement
in cross-strait relations given the recent
election triumph of the Pan-Blue coalition
has also rekindled some interest in the
market.
Topix rose modestly in local terms in 2004,
not quite meeting bullish investor expectations
for the year. Given that profit growth has
been strong, 2005 looks set to be a year
for cheaper stock-picking opportunities.
Credit expansion remains the foundation
for the Japanese economic recovery, which
raises prospects for banks and financials.
The long/short equity strategy should remain
popular among Japan-focused funds, given
its relatively successful track record to
date in harnessing the inefficiencies of
the Japanese stock market.
Japanese commodity stocks are expected to
benefit from the continuing strength in
construction. While there are concerns about
a possible property bubble forming in the
large cities, industry sources believe that
continued mass-migration from rural to urban
areas and growing availability of mortgage
finance to the expanding middle class will
ensure a healthy pace for residential construction
spending in the coming year. Furthermore,
efforts by the government to raise rural
incomes and the ability of farmers to now
take loans against their 30-year leasehold
rights are likely to further boost construction
spending in rural areas.
Strong consumption, aided by a weaker dollar
and falling interest rates, has fuelled
a good showing from Indonesia to date. With
a new, respectable government in place,
hopes are rising that a capital expenditure
cycle will occur and move the market higher.
Earnings growth remains strong and stocks
look relatively cheap.
In the Philippines, there is evidence of
credit growth and a rise in property sales
after 5-6 years of dormancy. Antiquated
mining laws, which have deterred foreign
investment in the mining industry for decades,
are also set to change. In December, the
Supreme Court abolished the law restricting
foreign ownership in mining companies to
40%. Given that the Philippines sits on
one of the richest mineral belts in the
world, this heralds an exciting new development
for resource development in the country.
There should be opportunities here worth
watching for in the coming year.
It seems likely that the greenback will
continue to weaken against undervalued Asian
and commodity currencies until the structural
problems in the US are resolved. Managers
expect to continue tracking the path of
the greenback carefully, in particular looking
out for indications of the pace and sustainability
of any decline or rally.
Concerns going forward
2004 was a year of extremes in financial
and commodity markets, and stock market
volatility fell on both an implied and realised
basis, reaching a 14-year low. The same
trends we saw in 2004 continue to play on
expectations for returns in the new year.
The consensus is that 2005 will be a year
of low, but positive returns and continued
low volatility in the equity markets. The
biggest threats to investor sentiment appear
to be a renewed rise in oil prices, a slowdown
in consumer spending in the US and UK (and
continued sluggishness in Europe), a hard
landing for China, where the government
is intervening to cool the economy, and
the continued deflation in Japan.
Observers worry that the weakness of the
dollar and historical low emerging market
spreads to US Treasuries have made global
investors oblivious to the risks associated
with investing in emerging markets. There
are warnings of imbalances appearing in
the investment world, whereby global investors
with very little experience with Asia hand
over increasing amounts of cash to hedge
funds.
1Based on funds that report to
Eurekahedge as at 31 December 2004 but not
including funds in the pipeline and funds
with multiple share classes/currency denominations.
2Through a combination of asset
flows and performance
3At press time
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