The Eurekahedge Report -October 2011

Hedge funds outperformed global equity markets yet again in September (-2.69% vs. -9.98% for the MSCI AC World Index) as managers focused on hedging strategies and short-term directional trades. All regional mandates finished the month with losses but fixed income and Latin American hedge funds are still in positive territory YTD. Managers lost more than US$37 billion in total assets through the month as investors accounted for US$20.98 billion of net outflows. Hedge funds now oversee US$1.76 trillion of capital - the lowest figure since March 2011.

Highlights of hedge fund performance and asset flows for the month are as follows:

September 2011	US$ billion
Allocation (Inflows)	7.58
Redemption (Outflows)	-28.56
Net Asset Flows	-20.98
Positive Performance (Growth)	12.08
Negative Performance (Decline)	-28.57
Total	-16.49
Overall Total	-37.47

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2011 Key Trends in UCITS III Hedge Funds

Introduction

UCITS III hedge funds have continued to post significant gains through 2011, both in terms of assets under management (AuM) and the total number of funds. As at end-August 2011 we estimate there to be 740 unique managers[1] with assets of nearly US$200 billion.

Figure 1: Industry growth since 2007

As shown in figure 2, UCITS III hedge funds have attracted proportionally greater asset flows when compared to the global hedge funds sector over the last two and a half years. Since 2008 against the backdrop of the financial crisis and some high profile frauds, hedge funds subscribing to the UCITS III framework have become increasingly popular as investors sought greater transparency, better risk management and more regulations from managers.

Figure 2: Growth of UCITS hedge funds relative to global hedge funds (%)

Launches and closures

Figures 3a and 3b show the fund launches and fund closures in global hedge funds and UCITS III hedge funds. In this figure all share classes are included to display comparative growth and attrition figures. Since the start of 2009, the total number of new hedge funds launched globally is 1696 while 797 UCITS III compliant hedge fund vehicles were launched.

Although launch activity in global hedge funds picked up since Q3 2009, the growth in UCITS III hedge fund population has been significantly greater. The main drivers of this growth are existing hedge funds launching UCITS III compliant versions of their funds and mutual fund companies launching hedge fund-like products. For existing hedge fund managers, a UCITS III version of their funds offers them a way to address investor concerns and are also an avenue to target new capital from European institutions as well as retail investors. On the other hand, mutual fund companies have utilised the flexibility within the UCITS III framework to offer products that can generate better risk adjusted returns. In addition, some hedge fund management companies have made wholesale changes to bring their operations within the UCITS III regulatory framework.

Figures 3a-3b-3c: Global and UCITS III hedge funds launches and closures

Geographic mandates

The breakdown of assets in UCITS III hedge funds by their geographic investment mandates are displayed in figures 4a and 4b. The main trend observed over the last few years is the decrease in the proportion of assets managed by funds allocating only to Europe. Although the region still accounts for 41.3% of UCITS III hedge fund assets, this share has decreased from 49.3% in August 2007. Funds allocating to other regions have grown to account for 10% of the assets while those with a global mandate have maintained most of their share.

Figures 4a-4b: Geographic mandates by AuM

Head office locations

Figures 5a and 5b compare the head office locations of global hedge funds and UCITS III hedge funds. Nearly 90% of UCITS III funds are based out of Europe, compared to only 35% of global (non-UCITS) hedge funds, indicating that UCITS is a vehicle for managers to target European institutional capital. While it is no surprise that most UCITS III hedge funds are based out of Europe, North America now accounts for 10% of the funds implying that the regulation is now becoming popular with American investors as well. Within Europe, the United Kingdom dominates as the location of choice, accounting for 47.7% of UCITS III funds and 20% of global hedge funds as it offers ready access to investors as well as service providers.

Figures 5a-5b: Head office locations of UCITS hedge funds vs. global hedge funds

Strategic mandates

In terms of strategic mandates, long/short equities continue to dominate the UCITS landscape accounting for 37% of assets. However assets in fixed income funds have increased to account for 30.1% of the total which reflects the lower risk appetite of European investors during the last two years. While the share of other investment strategies has also increased, it remains much lower than what is seen in global hedge funds.

Figures 6a-6b: Comparison of GHF and UCITS hedge fund strategies

Performance review

Figure 7 compares the performance of UCITS III hedge funds, global hedge funds, funds of funds and the equity markets; represented by the MSCI World Index. Over the last five and a half years the Eurekahedge UCITS Hedge Fund Index has gained 22.25%. This compares favourably with the performance of equities and funds of funds which recorded returns of 2.64% and 9.80% respectively over the same period of time. However, UCITS hedge funds underperformed global hedge funds as compliance to the regulatory framework requires managers to maintain liquidity and low levels of leverage – thereby limiting their upside potential. The Eurekahedge Hedge Fund Index was up 51.60%, over twice the return of UCITS compliant hedge funds.

Figure 7: Performance of UCITS hedge funds with other investment vehicles since 2005

Figure 8: Performance of UCITS hedge funds across strategies

Figure 8 and table 1 display the performance of UCITS III hedge funds by strategic mandates since August 2008. From August 2008 to August 2009, macro investing managers achieved the best returns of 9.35% as diversified portfolios and liquidity regulations enabled them to limit their losses and exit underperforming holdings. In the following 12 months from August 2009 to August 2010, almost all UCITS strategies finished with net gains, with the exception of multi-strategy and relative value managers. M&A activity was on the rise and event driven managers topped returns with a 4.76% yearly gain. As global markets softened during the last 12 months due to rising concerns about European sovereign debt, CTA managers delivered the best performance; up 6.34% amid gains in the commodities sector.

Table 1: Performance of UCITS hedge funds across strategies

	Arbitrage	CTA/ managed futures	Event driven	Fixed income	Long/short equities	Macro	Multi-strategy	Others	Relative value
2011 YTD returns	-0.67%	0.10%	-1.50%	-1.55%	-5.26%	-4.77%	-1.63%	-4.15%	-5.45%
12 month returns	0.60%	6.34%	-0.14%	-0.18%	0.33%	-2.63%	2.94%	1.52%	-5.29%
3 year annualised returns	1.52%	-2.88%	1.49%	2.17%	1.52%	3.05%	2.05%	1.46%	-1.55%

Source: Eurekahedge

In terms of regional mandates, Asia ex-Japan managers have been the best performers over the last three years while North American managers have delivered the best returns in the shorter term. In fact, North American funds were in positive territory for the year until July 2011 (up +2.45% July YTD). Despite that, managers lost 4.19% on average in August due to sharp market declines in August. Similarly, Asia ex-Japan managers experienced a 9.16% month-on-month loss in August which effectively negated their 2011 gains. In the last 12 months, Asia ex-Japan funds witnessed gains of 4.75% and have delivered an impressive 24.97% total return over the last three years. Hedge funds leveraged upon the strong economic recovery in Asia by going long on Asian assets which included currencies, corporate debt and equities; all of which locked in net gains by the end of three years. In contrast, the MSCI AC Asia Pacific Index was higher by 2.08% in three year total return terms.

Figure 9: Performance of UCITS hedge funds across geographic mandates

Table 2: Performance of UCITS hedge funds across geographic mandates

	Asia ex-Japan	Europe	Global	Japan	Latin America	North America
2011 YTD returns	-7.87%	-5.47%	-3.43%	-6.03%	-13.94%	-1.84%
12 month returns	4.75%	-0.83%	0.96%	3.68%	-0.57%	6.58%
3 year annualised returns	7.71%	0.74%	1.23%	-4.20%	3.79%	2.07%

Source: Eurekahedge

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[1] As opposed to multiple share classes, currency denomination and other replication offers

2011 Key Trends in Asian Hedge Funds

Introduction

Asian hedge funds have witnessed remarkable growth over the last decade in terms of both fund population as well as assets under management (AuM). As at August 2011 the total AuM in Asian hedge funds stood at US$135 billion; nearly six times that as of end-2000 while the number of funds increased more than six fold in that same period.

Although assets managed by Asian hedge funds peaked in 2007 at US$176 billion, the size of the region’s hedge fund industry was hit by the combined effect of redemptions and performance-based losses through the global financial crisis causing AuM to fall to US$105 billion in April 2009.

Figure 1: Industry growth since 1999

Since April 2009 the industry has witnessed healthy growth, gaining nearly US$31 billion over a period of 28 months. During this time the Eurekahedge Asian Hedge Fund Index has gained 27.4% leading to performance- based gains of more than US$15 billion. Record performance in 2009 also encouraged investors to allocate capital to the regional hedge funds. Over the last 12 months the sector has attracted nearly US$11 billion through net positive asset flows.

Asset flows

Table 1 details the monthly changes in AuM from January 2009 to 2011 YTD. In the first half of 2009, Asian hedge funds continued to witness heavy redemptions from investors, losing a total of US$26 billion. As managers started to post healthy gains on the back to rallying underlying markets, investor sentiment improved and the sector witnessed some net positive asset flows in 2H 2009.

Asian hedge funds started 2010 with expectations of strong inflows based on excellent 2009 returns and healthy allocation activity seen at the end of 2009. However after an initial period of profit-taking and portfolio rebalancing, a norm at the start of the year, most investors withheld allocations until the second quarter of the year amid concerns over European debt contagion spreading to emerging markets and Asia. Investor sentiment improved from May 2010 and since then the sector has gained US$12.8 billion through net positive asset flows.

Table 1: Monthly asset flows in Asian hedge funds

Month	Net Growth (Performance)	Net Flows	Assets at end
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	(0.2)	1.7	109.6
Sep-09	1.0	1.2	111.9
Oct-09	(0.0)	2.8	114.6
Nov-09	0.9	1.0	116.5
Dec-09	0.9	(0.1)	117.3
2009	10.1	(19.1)	117.3
Jan-10	(1.2)	(0.6)	115.6
Feb-10	(0.2)	(0.7)	114.7
Mar-10	2.2	(0.1)	116.8
Apr-10	0.9	(0.4)	117.3
May-10	(2.4)	0.7	115.5
Jun-10	(0.3)	0.4	115.6
Jul-10	1.1	0.5	117.1
Aug-10	0.4	0.4	117.9
Sep-10	2.8	0.5	121.1
Oct-10	1.8	1.9	124.8
Nov-10	0.2	0.7	125.7
Dec-10	2.0	0.8	128.6
2010	7.2	4.0	128.6
Jan-11	(0.5)	0.3	128.3
Feb-11	(0.1)	1.6	129.8
Mar-11	0.8	0.3	130.8
Apr-11	1.7	1.1	133.6
May-11	(1.2)	2.1	134.5
Jun-11	(0.9)	0.7	134.3
Jul-11	1.3	0.5	136.1
Aug-11	(1.2)	0.4	135.3

Note: all figures are in US$ billion                           Source: Eurekahedge

Launches and closures

After witnessing a high attrition rate in the 2H 2008 to 1H 2009, the population of Asian hedge funds has reverted back to a healthy growth trend. A total of 351 new funds have been launched since July 2009, as opposed to 236 fund closures. While launch activity has been encouraged by healthy performance of Asian hedge funds and strong growth in the underlying markets, attrition rate has fallen due to reduced redemption pressure as well as an increasing number of managers having been able to meet their high watermarks, and hence generate performance fees.

Figure 2: Launches and closures across Asian hedge funds

High watermark

As the high watermark differs from investor to investor depending on the net asset value (NAV) level at the time of capital allocation, we take the NAV of funds at December 2007 as the starting point for this analysis to determine if they are above their high watermarks.

Figure 3: Percentage of managers above 2007 December NAV

Fund Size

The current distribution of fund population according to AuM shows a significant difference from four years prior due to the strong directional trends in performance, heavy redemptions and high attrition rate suffered by the industry through the financial crisis. The percentage of funds managing US$50 million or less has increased from 54% in 2007 to 64% in 2011, suggesting that new launches have not attracted much capital and most of the allocations witnessed since 2H 2009 have gone to larger funds.

Figures 4a-4b: Breakdown of fund population by fund size

Geographic mandates

In terms of geographic investment mandates, the assets invested in globally mandated funds have witnessed the greatest growth. As globally investing funds did not suffer losses of the same extent as other Asian hedge funds in 2008, most of the capital allocated to hedge funds over the last two years came from institutional investors who prefer to invest in large global-mandated funds to gain exposure to Asia. The drop in the share of Asia including Japan and Japan focused funds, is primarily due to the closure of a few large funds over the last four years as well as the greater relative growth of global and China investing funds.

Figures 5a-5b: Geographic mandates by AuM

Strategic mandates

The most important trend here has been the decline in the share of long/short equity funds. The Asian hedge fund space was initially dominated by long/short equity hedge funds as it was the easiest implemented strategy that investors have traditionally been most comfortable with. However, easing of restriction in markets such as China and India, greater access to the markets and the growing availability of more complex financial instruments in Asian markets, has led to an increasing number of funds that employ different strategies. Additionally, long/short equity funds lost a major chunk of assets through the financial crisis due the rapid decline in equity markets globally.

Figures 6a-6b: Strategic mandates by AuM

Head office locations

The distribution of Asian hedge funds population by head office location also shows some significant trends that point to a maturing industry. In 2007, 40% of the funds were managed out of the UK and the US, as these were the traditional hedge fund centres. Over the last four years however, Hong Kong and Singapore have gained substantial market share from New York and London. The continued expansion of service providers in Asia, proximity to region of investment, and an increasingly large financially trained workforce have helped this move towards Asian-based funds.

Figures 7a-7b: Head office locations by number of funds

Prime brokers

Tables 2a and 2b display the breakdown of Asian hedge funds assets according to their 2007 and 2011 prime brokers[1]. The trend shows more equitable distribution of assets across the top 10 prime brokers as managers have started to use more than one prime broker as a measure to manage counterparty risk. The decreasing share of ‘Others’ also shows that funds prefer to work with larger, renowned and financially stable prime brokers in the post-Lehman world. New prime brokerages in the region have found it hard to break into the hedge fund business, and as such they have targeted niche sectors and the smaller hedge funds to gain a foothold in the sector.

Tables 2a-2b: Top prime brokers by market share

2007 Prime Broker Market Share Goldman Sachs 26.49% Morgan Stanley 26.62% UBS 9.15% Deutsche Bank 7.50% Credit Suisse 6.60% Citigroup 3.23% Merrill Lynch 3.77% Bear Stearns 9.13% Fimat 0.53% Others 6.98%

August 2011 Prime Broker Market Share Goldman Sachs 28.41% Morgan Stanley 24.38% UBS 13.24% Deutsche Bank 8.87% Citibank 8.30% Credit Suisse 4.56% Bank of America Merrill Lynch 4.40% Newedge 2.35% Barclays 2.10% Others 3.38%

Source: Eurekahedge                                                         Source: Eurekahedge

Administrators

The trend towards more diversification within the larger service providers is also apparent in the breakdown of hedge fund assets by administrators. HSBC continues to take the top spot as the largest Asian hedge fund administrator by market share - however the percentage share has fallen from 32.17% to 19.12% over the last four years. State Street has increased its share significantly with increased focus on Asia as well as the acquisition of Mourant International Finance Administration. The most noteworthy trend is the near 10% drop in the share of assets administered by ‘Others’, which includes in-house administration. The primary reason for this shift is the emphasis on regulations and transparency as no investor is willing to invest with managers lacking proper risk controls in place and reputed third-party administrators.

Tables 3a-3b: Top administrators by market share

2007 Administrator Market Share HSBC 32.17% CITCO 10.76% State Street 4.94% Citigroup 4.11% Goldman Sachs 3.36% PNC 2.91% JP Morgan 2.40% Morgan Stanley 2.03% Fortis 1.98% Northern Trust 1.95% Others 33.38%

August 2011 Administrator Market Share HSBC 19.12% CITCO 11.97% State Street 11.89% RBC Dexia Investor Services 9.81% Morgan Stanley 7.19% GlobeOp 4.32% Citibank 3.57% Goldman Sachs 2.93% JP Morgan 2.70% Meridian Fund Services 2.47% Others 24.01%

Source: Eurekahedge                                                       Source: Eurekahedge

Performance review

The performance of Asian hedge funds against the underlying markets and other alternative investments is seen in figure 8. Asian hedge fund managers outperformed Asian funds of funds and Asian long-only absolute return funds over the last five years. During the financial crisis in 2008 to 2009, the long-only index shed the most percentage points with a 51.15% drop from peak to trough while Asian hedge funds lost a maximum of 30.98%, displaying better downturn protection. Asian long-only funds also have a high beta with underlying markets as opposed to Asian hedge funds. When compared against the MSCI AC Asia Pacific Index, long-only funds registered a beta of 0.86 while hedge funds had a beta of 0.41 over the last five years.

Figure 8: Performance of Asian hedge funds vs. other investments since 2006

Within Asia, hedge funds allocating to Greater China have been the most profitable over the last three years with returns of 38.92%. In comparison, the Shanghai Composite Index only gained 9.21% in the same period of time. Funds investing in developed markets in the region; Australia/New Zealand and Northeast Asia have delivered more consistent performance recently.

Figure 9: Performance of Asian hedge funds across geographic mandates

Table 4: Performance of Asian hedge funds across geographic mandates

	Asia	Asia ex-Japan	Australia/ New Zealand	Greater China	India	Japan	Korea	Taiwan
2011 YTD returns	-2.88%	-4.94%	-2.63%	-4.97%	-12.75%	-0.30%	-2.09%	-4.08%
12 month returns	5.56%	4.79%	11.96%	6.03%	-6.76%	6.73%	6.56%	4.47%
3 year annualised returns	6.53%	8.06%	8.79%	11.58%	3.20%	3.68%	4.17%	2.09%

Source: Eurekahedge

All strategies delivered positive returns over the last 12 months as well as in the long term. Event driven hedge funds gained 14.20% in 12 months on the back of a robust corporate activity environment which has provided significant opportunities for managers. Total M&A deals during the first nine months of 2011 reached a staggering US$419.2 billion[2] within the Asia ex-Japan region, an increase of 16 percent in comparison to the January to September 2010 period. CTA Asian hedge funds also delivered excellent performance, locking in a total return of 34.40% over three years, outperforming the average Asian hedge fund by 13.51% in absolute terms. Regional long/short equity managers delivered a three year total return of 19.81%, beating the global average long/short equity fund’s performance by 5.5 percentage points.

Figure 10: Performance of Asian hedge funds across strategic mandates

Table 5: Performance of Asian hedge funds across strategic mandates

	Arbitrage	CTA/ managed futures	Distressed debt	Event driven	Fixed income	Long/ short equities	Macro	Multi-strategy	Relative value
2011 YTD returns	-0.66%	3.05%	1.65%	4.00%	3.60%	-3.87%	1.28%	-0.46%	-2.43%
12 month returns	3.67%	10.98%	10.29%	14.20%	8.34%	5.04%	3.00%	6.29%	2.00%
3 year annualised returns	4.20%	10.36%	4.88%	8.99%	6.07%	6.21%	7.31%	6.00%	8.87%

Source: Eurekahedge

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[1] Prime broker market share is calculated using the AUMs of the funds that supply their data to the Eurekahedge database. If the funds supply us with lists of multiple prime brokers that service them then the AUM is distributed equally amongst the prime brokers listed for the fund.

[2] According to Dealogic