Introduction
The Asian hedge fund sector grew at an exponential pace through the first eight years of the last decade before witnessing heavy redemptions in 2008 and early-2009 along with significant losses due to the financial downturn. The size of the region’s hedge fund industry peaked in December 2007, reaching US$176 billion; however, the combined effect of withdrawals and performance-based losses brought the assets under management down to US$105 billion in April 2009. Since then, however, the sector has undergone a remarkable turnaround in the last five months of 2009, attracting significant amounts of capital as well as posting record performances – the Eurekahedge Asia ex-Japan Hedge Fund Index was up 37% in 2009 – to bring the size up to US$117.4 billion dollars as at end-December 2009.
Figure 1 shows the growth in the number of hedge funds and the assets under management in Asian hedge funds since 2000.
Figure 1: Growth of the Asian Hedge Fund Industry
Asian hedge funds entered 2009 on a rather sombre note. Massive withdrawals flowing over from 2008 resulted in a sharp decline in assets during the first four months of the year, which also translated into greater performance-based losses due to forced selling and liquidating positions. Assets under management in Asian hedge funds declined by US$26 billion in the first half of the year due to net negative asset flows – a decline of 15%.
However, with a turnaround in the markets post-March, regional managers delivered some remarkable returns which served to regain investor confidence – the Eurekahedge Asia Hedge Fund Index gained 15.1% through March, April and May 2009..
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Industry Make-up and Growth Trends
Asset Flows
Table 1: Asset flows across Asian Hedge Funds
Month
|
Net Growth (Perf)
|
Net Flows
|
Assets at end
|
2007
|
23.2
|
20.0
|
176.0
|
Jan-08
|
(7.4)
|
4.4
|
173.0
|
Feb-08
|
2.4
|
0.2
|
175.7
|
Mar-08
|
(4.6)
|
2.5
|
173.6
|
Apr-08
|
2.0
|
(0.2)
|
175.4
|
May-08
|
0.5
|
(1.7)
|
174.2
|
Jun-08
|
(3.9)
|
2.7
|
173.1
|
Jul-08
|
(3.1)
|
0.1
|
170.1
|
Aug-08
|
(2.8)
|
(2.1)
|
165.2
|
Sep-08
|
(5.0)
|
(5.1)
|
155.1
|
Oct-08
|
(5.2)
|
(6.0)
|
143.9
|
Nov-08
|
(0.2)
|
(6.4)
|
137.2
|
Dec-08
|
1.2
|
(12.1)
|
126.4
|
2008
|
(26.0)
|
(23.6)
|
126.4
|
Jan-09
|
0.1
|
(9.1)
|
117.4
|
Feb-09
|
(0.2)
|
(4.7)
|
112.5
|
Mar-09
|
0.6
|
(4.6)
|
108.5
|
Apr-09
|
1.3
|
(5.1)
|
104.8
|
May-09
|
3.6
|
(2.6)
|
105.8
|
Jun-09
|
0.4
|
(0.2)
|
106.0
|
Jul-09
|
1.6
|
0.5
|
108.1
|
Aug-09
|
0.1
|
1.5
|
109.7
|
Sep-09
|
1.0
|
1.2
|
112.0
|
Oct-09
|
(0.0)
|
2.8
|
114.7
|
Nov-09
|
0.9
|
1.0
|
116.7
|
Dec-09
|
0.6
|
0.1
|
117.4
|
Note: All figures in US$ billion.
Source: Eurekahedge
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Asian hedge funds faced net outflows of US$19.1 billion in 2009; however, the bulk of the withdrawals were seen in the first four months amid heightened uncertainty about the global financial sector and concerns over the health of the global economy. Furthermore, gated redemptions in 4Q2008 were also a reason for such high outflows in the earlier months of 2009. The trend of withdrawals turned the corner in July as investor confidence in the markets continued to increase and they sought to catch the upside while also looking for downside protection.
Although net redemptions in the last two years totalled US$42.7 billion, the current AuM figure of US$117.4 billion still represents a remarkable compounded annualised growth rate of 24% over ten years since December 1999 – greater than the compounded growth rate of global hedge funds which is 19%. Furthermore, the compounded growth rate of the number of funds also stands at 24% despite a 6% decline in the number of funds since end-2007. It is interesting to note that while the assets over the same period shrank by nearly 33%, the fund population did not decrease by such a margin and this can be attributed to strong inflows and performances in the pre-financial crises period, providing a large financial cushion for fund managers as well as lower operating costs for funds based in Asia.
Going forward, we expect asset flows to pick up through 2010 as investors looking for consistent risk-adjusted returns over the long term, especially during times of uncertainty, look to allocate a larger portion of capital to hedge funds, owing to their proven ability to preserve capital when most other asset classes tumble (in 2008, the MSCI AC Asia Pacific Index lost 43.3% while the Eurekahedge Asian Hedge Fund Index shed 20.4%).
Attrition
Figure 2: Attrition across Asian Hedge Funds
As assets of Asian hedge funds increased over the years, the number of funds allocating to the region has also witnessed remarkable growth, with the population peaking in 2007 with 1,250 funds. Strong growth in the number of funds through the early-2000s was led by larger global fund management companies setting up Asian offices as well as new managers launching their own shops. The major reasons for the growth in the number of Asian hedge funds during this period are given as follows:
a) Recovery in the markets from the Asian financial crisis of 1997.
b) Perception of greater opportunity in Asia as a region developing at a fast pace led by China and India.
c) Greater access to Asian economies.
d) Increasing availability of more complex financial products in the Asian markets (such as the launch of so many more convertible bonds).
e) Increase in the number of high net worth investors in the region.
f) Availability of service providers in the major hedge fund centres of Singapore, Hong Kong, Tokyo and Sydney.
g) Lower costs of setting up offices in Asia vis-a-vis Europe and the United States.
h) The desire of large European- and US-based hedge fund-investing institutions to diversify into Asian alternatives.
i) Efforts of Asian governments to attract global managers (by offering tax breaks and straightforward regulatory filing).
However, the downturn in the global markets in 2008 and early 2009 led to a record number of fund closures. In 2008 alone, nearly 900 hedge funds closed shop globally, with Asian hedge funds making up 20% of the total closures and this trend of closures continued well up to 2009. The large number of closures can be attributed to the lack of performance fees (due to heavy losses suffered by managers in 2008) which are the main source of income for hedge fund managers, making it difficult for them to meet operational expenses. Most of the funds that did survive the year were those that had sound track records and huge earnings and savings for the past few years which helped them ride through the recent economic storm.
Although 2009 also witnessed a significant number of hedge funds closing down, the rate of the closures decreased in the second part of the year as managers started witnessing capital inflows as well as performance-based gains. The strong profits made by managers in the post-March period saw many of them crossing their high-water marks and accruing performance fees again, hence, relieving operational cost challenges as well as redemption pressure. As shown in Table 2, the percentage of managers above their high-water marks in December 2009 had increased to almost 30% as opposed to only 17% in end-2008. The turnaround in asset flows also led to an increased number of launches by the year-end – in 4Q2009, the number of Asian hedge fund launches was about the same as the number of closures while the full year saw a total of 84 launches and 94 closures in the regional hedge fund space.
Tables 2a-2b: Asian Hedge Funds above High-Water Mark in 2008 and 2009
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Going forward in 2010, we expect to see the number of hedge fund launches in Asia to increase and the fund population to cross the 1,200 mark by 2Q2010 considering the following reasons:
a) The recovery in Asian markets from the financial crisis was faster than most markets in the West, hence, making Asia a more attractive target market for investors.
b) There has been a significant number of highly-qualified financial professionals, such as investment bankers, proprietary traders and traditional fund managers, who, as a result of the financial crisis, have left/are leaving their previous posts to start their own hedge funds, especially with investors starting to allocate capital to the sector once again.
c) Asia is also home to well-developed financial centres such as Singapore and Hong Kong, which offer managers everything from talented, skilled, English-speaking staff at competitive costs (as compared to the West), a host of hedge fund service providers and a growing investor base, making it an economical yet efficient place to start a new fund.
d) With growing concern over the increasing regulations in the West, as well as new taxation laws aimed specifically at financial professionals, a rising number of hedge funds are looking to move their operations to Asian locations. A comparison of the top personal tax rates shows that while Hong Kong, Switzerland and Singapore tax 14 to 20% maximum, the rates in the US and UK range from 45% to 55% and as such, managers will prefer to relocate their operations to places where they can keep a higher amount of their earnings.
Fund Sizes
Figures 3a-3c: Breakdown of Hedge Funds by Fund Sizes
Over the last few years, the composition of the industry in terms of fund sizes has undergone some significant changes and is indicative of the performance, asset flows and growth within Asian hedge funds. For this analysis, we will compare the composition by size of Asian hedge funds at end-2009, June 2008 (when the industry was at its peak) and five years ago at end-2004.
Between 2004 and 2008, as the industry went through tremendous growth, the portion of small funds with assets of less than US$20 million fell almost 6% (as a proportion of a whole), suggesting that most of the existing small funds grew significantly due to healthy gains and strong inflows. Furthermore, as shown in Figure 2, there were more than 800 funds launched during this period and since Asian funds tend to start relatively small (as compared to funds launched in the West), it can be deduced that most of the funds in mid-2008 with assets less than US$20 million were new start-ups. This observation is also apparent in larger hedge funds as the percentage of funds with assets more than US$1 billion increased three times from 0.8% to 2.5% during this period.
The financial markets downturn induced considerable effects on the composition of Asian hedge funds by sizes. As of December 2009, the number of hedge funds with assets greater than US$1 billion constitute 1.1% of the sector, declining by more than half. This trend is observed across all the tranches of larger hedge funds, ie funds greater than US$100 million while the proportion of smaller funds has increased. However, since June 2009, the trend has reverted back to growth and with net inflows and performance-based gains, a number of the smaller are moving up into the larger funds’ category.
Geographical Mandates
Figures 4a-4c: Changes in the Geographic Mix of Asian Hedge Funds
The shape of the industry in terms of geographical investment mandates has also undergone significant changes over the years. Most prominent among these is the increase in the proportion of global-mandated hedge funds which currently make up 40% of Asian hedge fund assets, up from 31% in December 2004. Due to the strong growth in the regional markets, as well as continued potential for growth, most global-investing funds significantly increased their allocations to Asia through recent years. Additionally, global-investing funds did not suffer as much as regional-focused funds due to the diverse nature of their investments, thereby increasing their percentage weight in the Asian hedge fund industry.
Furthermore, the share of China and India focused funds has also recorded a two-fold increase – up from 4.5% in December 2004 to 8.6% in December 2009. This is due partly to the strong performances of the funds investing in these markets over the years as well as greater inflows. In Dec-2004 to Dec-2009 five year period, the Eurekahedge India Hedge Fund Index has gained 76.54% while the Eurekahedge Greater China Hedge Fund Index is up by a massive 184.61%.
At the other end of the spectrum are Japan-mandated funds which have lost half of their share of the Asian hedge fund universe in the last five years. This decline can be attributed to three consecutive years of negative returns (2006, 2007, and 2008) and subsequent redemptions as investors chose to shift their assets to other better performing markets in the region.
Strategic Mandates
Figures 5a-5c: Changes in the Strategic Mix of Asian Hedge Funds
The most prominent change observed in the composition of Asian hedge funds in terms of strategic investment mandates is the decline in the proportion of long/short equity managers – almost 20% over five years. Furthermore, this is not a sudden change in the aftermath of the credit crunch and the global markets downturn; instead, this is a sustained trend through the years which can be attributed to the increasing availability of other strategies in the regional hedge funds space, greater access and easing of restriction in markets such as China and India, and the availability of more complex financial instruments in the Asian markets.
As displayed in the Figures 5, the share of long/short equity funds had already fallen to 49% by June 2008 (when the industry reached its zenith) and declined further due to the steep downturn in global equity markets as managers faced both substantial losses due to performance and heavy redemptions from investors. The subsequent rebound in the equity markets in 2009 has somewhat stabilised the proportion of long/short equity managers at 42% and going forward, we estimate it to remain in the same range through 2010.
The share of event driven hedge funds’ assets increased to 19% in December 2009, up from 9% in December 2004. Most of this 10% increase took place through 2009 as event driven funds delivered excellent returns on average during the year. The regional managers of this strategy benefitted from strategic bets across the equities and other asset classes amid more corporate action and increased M&A activity in Asia, especially in the resources sector. The Eurekahedge Event Driven Hedge Fund Index gained a record 39.32% during the year – the largest gain on record across all strategies.
Head Office Location and Fund Domicile
The United Kingdom continues to hold the top position in terms of head office locations of Asian hedge funds, although its share of the pie has reduced over the last five years. The trend suggests that a significant number of the older Asian hedge funds were set up in the UK while there is currently greater diversification in the composition. The largest gainer in percentage terms has been the United States, which corresponds to the trend in geographic mandates over the year as the majority of global mandate funds are located in the United States.
Within Asia, Hong Kong continues to be the dominant hedge fund centre while Singapore has also gained some ground. Although Hong Kong did lose some of its market share as the global economy went through the financial downturn, it still accounts for more than 250 hedge funds as it was among the first in Asia to boast a wide-range of hedge fund service providers, making it an attractive location for managers to set up shop in.
Figure 6: Head Office Location
Figure 7: Fund Domicile
In terms of fund domiciles, Cayman Islands continue to be the location of choice for setting up hedge funds. Cayman offers friendly regulation as well as ease of fund set-up featuring a large number of service providers, such as law firms, accounting firms, and administrators – and with tougher regulations set to be introduced in the US and Europe we expect an increase in the number of Cayman domiciled funds.
Performance Review
Over the last few years, Asian hedge funds have been among the best performers[1] as managers have benefitted from growth and opportunities in the region. Rallying equity markets in China and India, as well as strong economic expansion in South East Asia, have largely helped managers post excellent results through the last decade. Furthermore, as the global economy recovered from the financial downturn in 2009, Asia-ex Japan markets were at the forefront of the revival – the MSCI World Index gained 26.99% in 2009 while the MSCI AC Asia Pacific ex-Japan Index was up by 68.41% during the same time. As such, it was also the Asia ex-Japan hedge fund managers that outperformed the average hedge fund manager globally – the Eurekahedge Asia ex-Japan Hedge Fund Index delivered record returns of 37.05% through the year which is the highest annual gain across all regional indices since December 1999.
Figure 8 charts the performances of different regional hedge fund indices over the last five years.
Figure 8: Eurekahedge (Regional) Hedge Fund Indices
A significant part of this outperformance by Asia ex-Japan funds can be attributed to the sharper-than-average bounce back in Asian equity markets (which had been sold off more aggressively than most other markets in 2008) as nearly 42% of the assets in Asian hedge funds are invested in long/short equity funds compared to about 30% globally.
Additionally, when considered over the long term, most of the upturn in the broad Eurekahedge Asian Hedge Fund Index (including Japan) over the past few years can be attributed to the performance of non-Japan funds as those investing in Japan had three consecutive years of negative returns between 2006 and 2008. As shown in Table 3, Asia ex-Japan managers have posted gains of 92% over the last five years while Japanese hedge funds are up by 13.8%.
Table 3: Comparative Performance across Broad Regions (December 2004 to December 2009)
Asia ex- Japan
|
Europe
|
Japan
|
Latin America (Offshore)
|
North America
| |
Total Returns (%)
|
92.0
|
40.7
|
13.8
|
70.8
|
56.1
|
Annualised Returns (%)
|
13.9
|
7.1
|
2.6
|
11.3
|
9.3
|
Annualised Standard Deviation (%)
|
11.7
|
8.2
|
6.8
|
9.0
|
5.9
|
Sharpe Ratio
|
0.9
|
0.4
|
-0.2
|
0.8
|
0.9
|
Not only did Asian hedge fund managers outperform their counterparts focusing on different regions, they also significantly outperformed the underlying equity markets in Asia. Figure 8 illustrates that Asian managers (including Japan) closely mirrored the sharp upturn in the equity markets between 2005, mid-2007 and 2009 while visibly protecting capital when the markets tumbled.
Figure 9: The Eurekahedge Asian Hedge Fund Index vs the MSCI AC Asia Pacific Index
Table 4: Asian Hedge Funds vs Equity Markets (January 2005 to June 2009)
Eurekahedge Asian Hedge Fund Index
|
MSCI AC Asia Pacific Index
| |
Total Returns (%)
|
57.9
|
18.8
|
Annualised Returns (%)
|
9.6
|
3.5
|
Annualised Standard Deviation (%)
|
9.1
|
20.4
|
Sharpe Ratio
|
0.6
|
(0.0)
|
Geographical Mandates
When considering the different geographical mandates within the Asian hedge fund landscape, funds investing in India and Greater China led the way, performance-wise, with 56.92% and 48.75% returns, respectively, for 2009. These returns broadly follow the performance of the underlying markets which posted massive gains in the year, with the Sensex gaining 81.03% and the Shanghai SE Composite Index posting 79.98% through 2009 while the MSCI Asia Pacific Index returned 34.46%.
Japanese managers on the other hand significantly underperformed their emerging markets-investing counterparts, delivering 6.73% for the year. This is partly owing to the relatively slower recovery in the country’s equity markets, which were affected by political uncertainty as well as an unfavourable exchange rate throughout the year – the TOPIX returned 5.63% in 2009.
Figure 10: 2009 Returns (%) by Geographical Mandate
The performance of Australia/New Zealand-focused funds is also noteworthy – the Eurekahedge Australia/New Zealand Hedge Fund Index returned 44.42% in 2009 which is the highest return to date for the index. Most of the returns were delivered by equity-focused funds, which make up more than 60% of the region’s hedge funds, as the Australian equity markets posted some significant gains through the year – the S&P/ASX 200 was up 37.03% in 2009.
It is also interesting to note that more than 85% of all Asian funds examined returned positively in 2009 and this number goes up to more than 92% when considering funds focused on India, Greater China and Australia/New Zealand. At the lower end of the spectrum are Japan-investing hedge funds which have about 68% positive returning funds for 2009.
All in all, 2009 has been a record year for Asia, especially for hedge funds focused on the growth markets. All investment regions have been positive through the year, with China-, India- and Australia/New Zealand-focused funds delivering the highest returns on record for their respective hedge fund indices. Going forward in 2010, we expect the growth trend to continue, albeit at a more measured pace.
Strategic Mandates
In terms of strategic mandates[2], all strategies delivered positive returns in 2009, with arbitrage managers faring the best, gaining 50.86%. Asian arbitrage hedge funds capitalised on the strength of corporate credit markets and the reopening of capital markets which contributed to the revival of the convertible bonds sector. The sustained rally in the bonds sector, continued high yields through the year and improved valuations in the convertible bonds section, as well as a record volume of attractively priced new issuances (especially in Emerging East Asia), provided a favourable opportunities for arbitrageurs to post excellent returns for the year. Similar movements also worked to the advantage of relative value and distressed debt hedge funds managers who delivered returns of 32.93% and 24.17%, respectively, for the year.
Other significant performances were posted by event driven and long/short equity managers, up 32.10% and 30.81%, respectively. Although equity-focused managers suffered greatly in 2H2008 and 1Q2009, the sharp rally in the global equity markets post-March 2009 was even more pronounced in Asian markets, as highlighted in the previous section, helping managers to post record returns for the year. Regional event driven funds also took advantage of the market rallies by making strategic plays in the equity space while significant M&A activity in the region also benefitted the managers.
Figure 11: 2009 Returns (%) by Strategic Mandate
Asian long-only absolute return managers posted record gains of 53.19% after a disappointing spell in 2008, benefitting largely from the sharp upturn in the underlying equity markets. However, their returns for the two-year period remain in the red, owing to the steep losses suffered in 2008 – the Eurekahedge Asia Pacific Absolute Return Fund Index lost 45% in 2008.
The healthy returns in 2009 have helped managers of most strategies to offset the losses they suffered through 2H2008 and 1Q2009. Currently, the only hedge fund indices which are still below their historical highs are long/short equities and distressed debt as the managers of these strategies suffered the most losses during the global economic downturn.
Changes in Fees, Administrator and Prime Broker Landscape
As the global finance industry recovers from the credit crunch and the financial crisis, there is an increased pressure on hedge funds to change the way they function, especially in terms of regulations, transparency and fees. Hedge funds located in Asia have, however, had to comply with mandatory regulations even before the financial downturn and as such, these funds are better prepared for further compliance measures. Ever since the Asian financial crisis of the late 1990s, Asian hedge funds have been more tightly regulated and have been required to have third-party administrators; however, Asia-investing funds located in Europe and North America are now also moving to this practice, especially since the Madoff fraud. Tables 5a-5b shows the changes in the administrative landscape in Asian hedge funds.
Tables 5a-5b: Top 10 Asian Hedge Fund Administrators by Assets under Administration
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Although the top two have remained unchanged, there have been some changes in the overall composition of the hedge fund administration landscape. This is primarily the result of wholesale subscription by funds located in Europe and the United States since in the post-Madoff world, no investor is ready to invest with managers who do not have the proper risk controls in place and third-party administrators. Additionally, a number of smaller hedge funds, which earlier used to administer their assets themselves, have also changed to this model and since they do not have economies of scale working for them, they employ the services of relatively inexpensive administrators, hence, contributing to the changes observed in the tables. Furthermore, some of the larger hedge funds which had internal administrative capacity have also set up third-party administration services, hence, further contributing to the changes observed.
Tables 6a-6b: Top 10 Asian Hedge Fund Prime Brokers by Assets under Administration
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The prime broker industry for Asian hedge funds has also gone through some significant changes. Before the crisis, it was the prime brokers that had put in measures for counter-party risk; however, after the crash of two of the largest financial institutions, fund managers are now also wary of their dependence on prime brokers. The Asian hedge fund industry currently has greater diversity in terms of prime brokers as compared to 2007, when two institutions accounted for more than 50% of the market share. Furthermore, there is an increasing trend of hedge fund subscribing to two or more prime brokers, bucking the earlier trend of depending only on institution.
In addition to changes in the administrator and prime broker landscapes, we have also observed some significant trends in the fee structures of Asian hedge funds. Although average annual management fees have not changed significantly (down from 1.85% to 1.67%), there has been a significant change in the average performance fees of Asian hedge funds launched in 2009.
Table 6 shows the average fees charged by funds launched over the recent years. The fee structures of new launches remained pretty much the same until 2008 and it was only after the financial downturn that managers responded to calls from investors to lower their performance fees. However, a change from 19.4% to 17.9% is not much as seen in other regions which suggest that managers launching new funds are confident about delivering positive returns in the future.
Table 7: Average Fees by Launch Year
2005
|
2007
|
2009
| |
Average Management Fees
|
1.72
|
1.85
|
1.67
|
Average Performance Fees
|
19.41
|
19.40
|
17.90
|
Conclusion
The Asian hedge fund industry has undergone tremendous growth in the last decade through performance-based gains as well as asset growth from subscriptions. The number of funds has grown from less than 200 in December 1999 to almost 1,200 in December 2009 as interest in the region has increased along with sustained growth in the underlying markets and the increasing presence of service providers.
Although the sector went through some troubled times in 1H2008 and 1H2009 due to massive redemptions, coupled with significant performance losses owing to tumbling equity markets, the industry has come through the crisis with an enhanced reputation. Offering greater regulatory protection than their counterparts in Europe and North America, Asian managers also boast access to emerging markets and potentially greater returns. As discussed earlier in this report, Asian hedge funds have consistently been the best performers among the global hedge funds universe while also outperforming the underlying markets in the longer term.
After witnessing widespread redemptions for almost a year, Asian hedge funds started seeing net inflows through July 2009 and by the year-end, the subscriptions become stronger and more consistent. Going forward in 2010, we remain bullish about the prospects of the Asian hedge fund industry both in terms of performance and asset flows. As investors now look for consistent long-term returns from the Asian markets, they are turning towards hedge fund managers who have historically captured most of the upside while also protected capital reasonably well on the downside (as shown in Figure 8). We expect inflows to pick up gradually through 1Q2010 and remain steady for the rest of the year to bring the size the industry to US$140 billion by the end-2010.
