RIC WONG, who helps run his Hong Kong family’s money through an investment office, TCG Capital, looks like a hedge-fund manager’s dream. He’s rich, young and, having been to university there, comfortable with American ways—just the type of investor that Western hedge funds looking for Asian expansion have set their sights on. He is not, however, very interested. Real estate is the “best pension plan my family ever had,” he says. Why change?
Where they are not greeted with apathy, Asia-minded hedge funds often face antipathy. Since the financial crisis of the late 1990s “fund” has been a four-letter word throughout Asia. George Soros, a famous hedge-fund investor, is still reviled for aggravating and profiting from the crisis. When the Chinese refer to hedge funds as ju e, or “big crocodiles”, it is not by way of a compliment on their killer instincts.
Despite muted interest and outright scorn, though, more and more hedge-fund managers are determined to make their mark on Asia. They see a lot of money to be made, a lack of entrenched competition and a vast number of potential clients.
Ravenous growth and maturing equity and credit markets should mean Asia offers a lot of opportunities. “Our investable universe has doubled in the last five years,” says one happy executive at a fund that recently launched in Hong Kong. At the same time there is little by way of an asset-management industry in much of Asia. Investors’ portfolios mostly consist of just property and stocks, which leaves lots of room for hedge funds’ offerings. And there are vast numbers of millionaires to whom such offers can be made.
If the hedge funds succeed they could help spur Asian capital markets to grow bigger and more versatile. Few parties have more of an interest than they in seeing Asian markets become more liquid and more complex, since trading is how they make their livelihood. A wider range of financial products could in time also prove a boon for Asian pension funds and others taking stock of the issues raised by the ageing population’s future needs. But building the industry up will not be an easy task; it will take new local knowledge, new approaches to investing and new levels of performance.
Getting beyond the graveyard
It is not as if hedge funds had previously ignored Asia. They have just done poorly there. “Asia is a hedge-fund graveyard,” one executive says matter-of-factly. Another corpse is about to be buried: Perry Capital, a big American hedge fund, recently announced plans to close its Hong Kong office. Assets in Asia-focused hedge funds now stand at $130 billion, well below their 2007 peak (see chart 1), and account for less than 8% of the $1.8 trillion invested in hedge funds globally. They saw just $11 billion of net inflows in the past 12 months. The number of funds, once soaring, has in the past few years merely held steady.
New attempts to buck this trend come not just from an appreciation of Asia’s promise. The lack of promise elsewhere plays a big part, too. Hedge funds have suffered some stormy years in their traditional stomping grounds of New York, Greenwich and London. Having once guaranteed investors “absolute returns”, or performance regardless of the market conditions, their returns over the past three years have been mixed and often dismal. Finding American and European investors willing to pay high fees and write big cheques is hard.
So new managers are arriving in Hong Kong and Singapore each week to seek out prospective clients and preach the importance of portfolio diversification. And since the start of 2010 many funds have been opening offices in Asia, including giants like Moore Capital, GLG and Paulson & Co. A slew of new funds has also launched in Hong Kong and Singapore. In April Azentus Capital, a Hong Kong hedge fund, was able to raise over $1 billion in Asia’s largest-ever hedge-fund launch. Bill Lu, president of Hong Kong-based hedge fund Ortus Capital and former head of hedge-fund investing for China’s sovereign-wealth fund, CIC, expects the assets funnelled to hedge funds in Asia to double in five years.
This is in part because Asian governments have recently been more supportive of the funds. Earlier this year Shanghai’s government sent a delegation of people to Connecticut to study how Greenwich became a hedge-fund mecca, a trick the city would like to pull off itself one day. Hong Kong and Singapore are keen to become hedge-fund capitals to rival New York and London, and are working hard to craft regulatory regimes that will help. They require hedge funds to register, but aren’t as demanding as America and Europe, which have passed new rules that increase the cost of starting and running funds. And income-tax rates for high earners in Hong Kong (17%) and Singapore (20%) are much lower than in Britain (50%). That’s a powerful argument to a footloose trader.
The enthusiasm is not just in market-oriented cities. South Korea recently changed rules to allow onshore hedge funds for the first time. Asian sovereign-wealth funds, including not just Singapore’s GIC and Temasek but also China’s CIC, have in the past couple of years started to funnel money into hedge funds.
What’s in a name?
Despite some signs of government enthusiasm, both the Western hedge funds making inroads in Asia and the native funds sprouting up there face markets that are tricky to navigate. Each Asian country has different regulations. Whereas Europe has its UCITS funds, accepted in all EU countries, there is no pan-Asian marketing vehicle for hedge-fund managers. Taiwan doesn’t allow offshore hedge funds to invest there, or to market themselves. The sixth-largest equity market in the world, Shanghai is at present mostly off-limits to investors outside mainland China, though optimists predict some restrictions will ease in the next few years.
Then there’s the bad reputation. Investors may be willing to sit down with crocodiles and hear their pitch, but they are often not eager to invest afterwards. Many, like Mr Wong, don’t see why they should pay a manager high fees (usually 2% of assets and 20% of profits) when they have been handling their own money pretty successfully. It doesn’t help that many big Western hedge funds are accustomed to asking for tens of millions of dollars at a time. Asia’s wealthy like to start with a small allocation to test the waters. And the waters they prefer to test may be those of private-equity firms, with which entrepreneurs who made their fortune building companies are often more comfortable. KKR, an American buy-out firm, has plans to raise a $6 billion Asian fund, an amount the crocodiles would kill for.
The rocky track record of some iconic hedge funds has further troubled potential investors, says Daniel Jim of Tripod Management, which advises Hong Kong investors on hedge funds. Those who invested in hedge funds before 2008 recall bitterly how some of them “gated” investors, refusing to let them take out their money. One manager had the chutzpah to come back to Hong Kong recently and ask a client with money still locked up in his fund for more. The investor went to his office, got the fund’s legal documents and threw them at him.
Some hedgies try to dodge these negative associations. “We try not to emphasise in presentations that we’re a hedge fund,” says Jimmy Chan, the boss of Value Partners, a publicly listed hedge fund and long-only manager. Yang Liu of Atlantis Investment Management, a $4 billion fund that reportedly counts bigwigs like the Bill and Melinda Gates Foundation among its investors, insists she offers “absolute-return products” and “not really hedge funds”.
Another risk for foreigners is how well they know the countries and companies they’re invested in. Take, for example, John Paulson, the hedge-fund guru who made billions of dollars predicting America’s housing crisis. Recently he faced losses to the tune of $500m after a short-seller alleged that a company Mr Paulson invested in, Sino-Forest, didn’t have the timber stocks it claimed: its shares tanked before the Toronto stock exchange, on which it was listed, suspended trading in it. Yet an outside eye can sometimes see things that locals can’t or won’t. Sniffing out fraud and shorting its perpetrators has been a nice earner for Asia’s hedge funds.
For home-grown hedge funds the big problem is not being wrong: it is being small. Around 41% of funds in Asia manage $20m or less, and only 2% manage more than $1 billion, according to Eurekahedge, a research firm. This means they are going to be less attractive to sovereign-wealth funds and big institutions, which write large cheques, do not want to be too much of a fund’s investor-base and are often expressly looking for exposure outside Asia.
That makes foreign investors wanting some Asian growth an attractive prospect for small funds keen to grow. But in the aftermath of the Madoff scandal many investors are loth to put their money with any fund that does not have rigorous (read: costly) compliance and reporting schemes. And hedge funds are not in principle the place for bullish bets on Asian growth. In a bull market hedges should diminish returns. Paul Smith of TripleA Partners, which advises foreigners on investing in Asian funds, says there is twice as much money looking for long-only funds as for hedge funds.
For that minority which wants the security that hedging offers, the Asian hedge-fund record is still not compelling. They tend to tank when the markets fall (see chart 2). Asian funds are more invested in equities than hedge funds in general, and they take long positions more than short ones—hence the correlation. Since investors in search of an equity roller-coaster ride can buy index-tracking products a lot cheaper, hedge-fund managers need to demonstrate their investment skill better, and offer strategies besides just going long or short on equities. Funds are trying to distinguish themselves by focusing on countries (Japan and China) or instruments (emerging-market currencies).
Many managers have learned lessons from the trauma of the past few downturns and tried to devise ways to cope with the volatility of Asian markets. “If you manage money in Asia, you ought to expect the market to go down 50% every 3-4 years,” says John Ho, the founder of Janchor Partners, a large hedge fund. Investors in Janchor have agreed to lock up their capital for longer, around 2.6 years on average—an eternity in hedge-fund land. This means Mr Ho won’t have to worry about investors running for the exit the next time the market goes down. But until such approaches have a track record of success investors may stay skittish.
The Orient express
Enthusiasts think eventual success for the hedge funds would bring wider benefits. In moving away from equities towards corporate bonds, currencies and new derivatives the funds should add to the liquidity and sophistication of Asian markets. Raising capital will be easier and cheaper when there are more hedge funds hungry for debt or equity. Hedge funds sniffing out fraud will be good for other investors, too.
And then there are changes in the markets which could alter the prospects for hedge funds. Recent signs pointing to trouble in the Asian equity and property markets could move investor sentiment their way. A serious slowdown could show wealthy Asians the merits of putting money into assets other than just equities and property. According to one hedge-fund executive, “I think a slowdown…in Asia could be the best thing to happen to hedge funds here.” For that to pay off, though, the funds will have to ride out the falls in asset prices well. Asia may yet come to love its crocodiles. But they will have to show that they can swim in choppy waters.