Hong Kong: Asian hedge fund managers will likely close down or be bought out in growing numbers this year in a painful bout of consolidation triggered by financial market turmoil.
Combined with tougher barriers for potential start-ups, the number of Asian hedge funds could actually shrink in the near term, putting a still-growing pool of investor cash in the pockets of larger, established players, industry executives told the Reuters Hedge Funds and Private Equity Summit this week.
Hedge funds are private investment partnerships that cater largely to institutions and wealthy people.
“Investors are demanding more of managers in regards to operational infrastructure, compliance, risk management ... you have to have a critical mass of assets under management to be able to pay for all of that,” said Eugene Kim, chief investment officer of $250 million (Rs1,000 crore) hedge fund manager Tribridge Investment Partners Ltd.
“A lot of marginal managers who have not been able to make it to the next level in terms of fundraising, in terms of size, are either going to have to merge or get bought out or shut down.”
Asia-Pacific focused hedge funds, which had about $156 billion in assets at the end of February according to hedge fund tracker Eurekahedge, are among the industry’s worst performers globally since the start of this year.
After producing five straight years of double-digit percentage gains, the Eurekahedge Asian Hedge Fund Index is down 7.26% this year. This compares with declines of 1.53% and 3.49%, respectively, in its North American and European indexes.
Ferenc Sanderson, senior research analyst with Reuters-owned fund information supplier Lipper, predicted the hedge fund attrition rate in Asia would be more than twice the global average of about 8%.
He said many hedge fund managers and wealthy individuals had already started pulling their cash out of falling Asia-focused funds.
“The bloodletting is in full swing,” he said.
Asian hedge funds were hit hard by tumbling stocks, partly because equity-focused long/short funds are overrepresented compared to more developed markets.
While these funds are supposed to profit in both rising and falling markets because they can sell stocks short (i.e. sell a stock without owning it), in many cases they are long-biased, preferring to buy and hold shares.
MSCI’s measure of Asian stocks outside Japan dropped more than 14% in the first three months of 2008, its worst quarterly performance in more than five years.
Hedge funds globally have also seen their ability to borrow money from their prime brokers tighten amid a global credit squeeze spurred by the US subprime mortgage meltdown. Many of the brokers’ own parent banks are facing huge credit problems of their own.
Many hedge funds use leverage in a bid to boost returns, though Asian funds are less reliant on that on average than US and European managers. Leverage refers to the use of borrowed assets by a business to enhance the return to the owner’s equity.
“In a year or two years from now, we’ll see more dollars in Asian hedge funds. Dollars allocated will grow. But I think we’ll see consolidation. There will be a lot of guys that will shut,” said George Long, chairman of $1.5 billion hedge fund manager LIM Advisors.
“The long/short model will be under some pressure. We hear it all the time that Asian long/short hasn’t added value. It was up a lot last year and then it crashes. What people are realising is it’s a very high beta strategy,” Long said.
Beta refers to the volatility of an investment relative to the overall market.
Long, a hedge fund industry veteran who founded hisfirm in 1995, said this should benefit managers using alternative investment styles like multistrategy, special situations and market-neutral, which are less reliant on rising stock prices.
He said the number of hedge funds in Asia could shrink in the near term because it’s a tough time to raise capital and many funds were being hit by redemptions.
SHK Fund Management Ltd chief executive Christophe Lee said the amount of assets needed to start up a hedge fund had jumped in recent years as institutional investors, which include pension funds, had put a bigger onus on issues like risk management.
He said multistrategy funds now likely needed at least $50-100 million to start out, while a long/short equity manager might be able to get away with $20-30 million.
“The $5-10 million days are gone ... it’s very hard for a $5-10 million fund to grow,” he said.
Kim noted the threshold for new managers had risen sharply since Tribridge, which launched its flagship fund in 2005, was established.
“We launched with $15 million. Today I don’t think you could launch with $15 million. I think it’s going to be multiples of that that you need,” he said. There are also fewer investors willing to bet on an unproven manager given the spike in market volatility.
“We like managers who have a little bit of scar tissue,” John Knox, co-founder of KGR Capital Ltd, which manages several portfolios of Asia-focused hedge funds, told the Reuters Summit.
Kim said relative to US and European hedge funds, Asian funds were less likely to suffer from blowups because they tend to employ less leverage, though he noted some could be caught out by the difficulty of valuing less liquid securities.
The region suffered a rare meltdown last year when Australia’s Basis Capital Pty Ltd was slammed by the losses on investments in complex collateralised debt obligations.
Long said that while more failures in Asia are possible, because Asian funds typically employ less leverage, “it’s more of a bleeding scenario.”