HFR’s November 2016 Asian markets hedge fund industry report found that total capital invested in Asian hedge funds increased to $111.8bn in the third quarter of last year, recovering the decline from the previous three months but remaining below the record high of $119.8bn reached in 2014.
Chinese hedge funds posted strong gains as the Shanghai Composite Index pared 2016 losses and the renminbi stabilised, while hedge funds focused on investing in Japan also produced positive returns as the yen posted intra-uarter gains against the US dollar and year-to-date losses on the Nikkei 225 were pulled back.
Asian hedge funds navigated intense regional equity and currency market volatility in 2016. With the macroeconomic and political overhang of both the US election and Brexit now removed, and as global M&A activity continues to accelerate, HFR president Ken Heinz expects specialised Asian hedge fund strategies to attract global and institutional investors in 2017.
“Interest in quantitative hedge funds in Asia has continued to expand, but they have been popular with Asian investors for some time and while Asian equity markets clearly declined in early 2016, there is no evidence of a causal relationship,” he says.
According to Eurekahedge analyst Mohammad Hassan, this trend is a reflection of quantitative strategies being able to identify, process and step into potentially lucrative trades ahead of the crowd. “Systematic strategies with exposure to commodity futures have the added benefit of low correlations to traditional equity market focused strategies. While there has been gravitation towards quant strategies globally, there is a real worry that perhaps there are too many copycat strategies out there crowding out trades.”
Growing interest in quantitative hedge funds in Asia is perhaps an indication of a potential longterm trend towards computer-driven strategies. Peter Douglas, Singapore-based principal of the Chartered Alternative Investment Analyst (CAIA) Association suggests that it is more about the rapid development of super-fast computing power, the development of tools to extract information from big data and the potential of machine learning.
“Any successful alpha strategy must, by definition, be doing something different from the mainstream and what we are seeing is a race to stay ahead of the technological curve,” he says. “It should also be noted that any computerdriven strategy is only as good as the minds that conceived and built it. The industry still needs the smarts to make this work.”
Philippe Ferreira, senior cross asset strategist at Lyxor Asset Management, says growing interest in quantitative hedge funds in Asia reflects a rebalancing between discretionary and systematic strategies. “Systematic strategies are attractive for portfolio diversification purposes, yet some long/short equity managers have faced more difficulties in reducing risk and protecting capital recently. Hence part of that growing interest in quantitative hedge funds in Asia is related to diversification purposes and the ability of quantitative strategies to have lower correlation to traditional markets. Disappointing equity returns have also played a role, though.”
Foresee Global Asset Management (HK) partner and CEO, Tom Weiye Tang, says this has remained a theme. “Disappointing equity returns in 2016, especially in China, have driven money towards computer-driven strategies. The average performance of Chinese quantitative funds easily beat that of the long-biased funds last year and more and more investors are turning to quant strategies for stable and low risk returns in times of increasing uncertainty.”
Another factor behind strong fund flows into quantitative strategies in Asia is the desire for attractive risk-adjusted absolute returns where investors are not also being overcharged for beta, adds Robert Frey, founder and chief investment officer of FQS Capital Partners.
Reliance on equities
Heinz accepts that Asian hedge funds are more reliant on equities than their international counterparts, observing that 76% of Asian hedge fund capital by AuM is in equity funds compared with 61% for the global industry. The disparity is even greater when measured by the percentage of hedge funds that are equity ones – 76% in Asia versus 47% globally.
Tang agrees with the view that Asian hedge funds are over-reliant on equities, noting that hedge funds based in Asia ex-China are predominantly trading long/short equity strategies and that alternative strategies such as CTA funds are hard to find. “In comparison, there are many more CTA funds inside China due to its extremely liquid commodity futures markets. The fact that China’s commodity markets are still closed to offshore investors, together with the lack of active commodity exchanges in Asia outside China, is one of the main reasons that Asian hedge funds are over-reliant on equities.”
As Asian markets become more mature and sophisticated, it is only normal to see the hedge fund industry expanding outside of its traditionally long-biased equity space, suggests Frey. Moreover, its underlying market dynamics – with substantial volatility, liquidity and active participants – provide a fertile ground for all type of arbitrageurs, whether quant, macro or discretionary stock pickers.
“For instance, the Chinese market looks particularly attractive and we have seen a handful of successful managers in this area, but the key to making this a great opportunity for the long term will be the attitude taken by regulators and the ability for hedge funds to adapt. Shorting remains an issue and recent changes such as limiting futures hedging have made it even more difficult for arbitrageurs to operate,” he continues. “We hope that as this market opens up further, the opportunity set will increase.”
Hassan is more confident, noting data on the most popular strategies from 2008 to 2016 illustrate that reliance on long/short equities has fallen over that period, although it is still some way ahead of multistrategy. This view is shared by Douglas, who observes that Asian hedge funds merely reflect the opportunities available to them and that the reliance on equities over other assets or contracts is a function of the underlying capital markets of the region.
“Asia – especially Greater China – is one of the most commercially active regions in the world and we see managers diversifying their portfolios into other asset classes to generate a good balance of asset allocation that is in accordance with the fund’s strategy,” adds Tony Kan, managing director of Custom House Fund Services Hong Kong. “The other asset classes that managers are diversifying into include OTC corporate bonds seeking stable yields, private placements and later stage pre-IPO deals to take advantage of growing investment opportunities in Greater China.”
Stephane Macresy, head of hedge fund selection Asia at Lyxor Asset Management, notes that event-driven and long/short equity managers constitute the bulk of the strategies in Asia but also that other strategies have achieved positive returns. “Global macro, CTA and multi-strategy managers have also experienced great success, while relative value credit or volatility strategies are gaining momentum. So the issue has not been over-reliance on equities but rather the inability of traditional equity strategies to adapt to changing market conditions.”
Eurekahedge data highlights a 60% increase in event-driven hedge fund AuM between 2008 and 2016, although the total for last year was approximately 18% down on the figure for 2011.
Private equity competition
There has been much talk of reallocation of assets from hedge funds to private equity in Asia, particularly by family offices with aggressive performance goals. UBS’s 2016 global family office report notes a 0.9% decrease in hedge fund allocations and that this pattern is likely to be reinforced with family offices planning to move more money into private equity.
However, Hassan is unconvinced that this is indicative of a major shift in investor sentiment. “Private equity has historically sat well with Asian investors who like the idea of buying into a business and having some control over its destiny. Recent reports of reallocations from hedge funds to private equity have manufactured trends out of isolated events – with dry powder at historical highs in the private equity space, one needs to evaluate this more carefully. The opportunity set of hedge fund strategies is more diversified than it was 10 years ago. Asian hedge fund AuM is still around 8% of total global money invested in hedge funds so there is much room for growth here, although it is going to take some time.”
This sentiment was echoed at an EisnerAmper-sponsored Chinese Alternative Asset Management Professionals (CAAMP) event in late 2016, where participants were told of how Asia’s hedge fund industry was undergoing a transformation. These changes include a shift from historically equity-centric managers to a broader set of strategies (including multi-strategy, Asian macro and credit-focused strategies) as well as North American investors paying more attention to Asian managers.
Macresy accepts that there may be some consolidation in the Asian hedge fund space and more managers entering liquid alternatives. But, within alternative investments, he expects private equity and hedge funds to grow in parallel. “Whereas large Asian investors have mainly been allocated to global brands, we expect that both Asian and overseas investors will focus more on Asian hedge funds, while investing in private equity, infrastructure and real estate continues to form a strong trend for investors in the region.”
Assets have been reallocated to private equity funds in Asia due to the lack of diversity and performance of Asian equity-focused hedge funds, but the private equity space is becoming overcrowded with too much capital. That is the view of Yang, who is confident that quantitative hedge funds will attract assets looking for private equitystyle returns, due to their diversification benefits and low-risk nature.
It cannot be denied that Asian hedge fund managers face capital raising challenges that are exacerbated by extreme distances between managers and the investors they wish to attract and an industry that is still in its infancy compared to North America and Europe.
As Douglas observes, the institutional capital that is being “forced” into alternative assets prefers to collect illiquidity premia from private equity, direct lending, real estate and other long term assets. “These premia are inherent to the underlying asset and hence are perceived to be more sustainable than the ‘skill-based’ premia of hedge funds,” he says.
However, the fact that North American investors – including family offices, funds of hedge funds and other groups looking for early-stage managers – are looking to Asia-based managers for returns with low or no correlations to those in North America and Europe should encourage regional firms, especially those who are able to demonstrate nimbleness and agility.