The hedge fund industry in Asia has been steadily recovering in the wake of the global financial crisis. Even so, there is still some way to go before all the lost ground is regained.
Between June 2004 and June 2011, total assets in Asian hedge funds increased from $49 billion to $144.7 billion, but total assets under management are still well below the $197.7 billion peak they reached at the end of 2007, according to HedgeFund Intelligence.
There is little doubt that Asian funds, and the firms that manage them, are faced with many challenges. The progressively stringent regulations affecting the industry are not just local or regional in nature but global, requiring a new, wider perspective and understanding.
The continuing economic slowdown in Europe, and economic and political instability elsewhere, are making their influences felt. Allocations to Asia will continue to rise, especially from larger investors and allocators, because of the strong economic fundamentals.
That said, new capital is still hard to come by. This is linked to liquidity concerns in the asset class and also the fact that the desire for return is tempered by an increased focus on due diligence and enhanced demands by investors of their managers.
As the industry looks to deliver higher returns to investors, managers re-establishing themselves need to have redefined objectives. In particular, investors are asking managers to minimise risks and deliver returns as well as seeking to invest with well-run organisations that have good compliance and governance.
In turn, managers want to align themselves with quality counterparties that can deliver best-of-breed operational infrastructure and compliance controls.
Building a sustainable business model
The proportion of Asia-based hedge funds, by number and value, managed from the US and the UK is in relative decline, as more funds are now managed from Asia.
Although US and UK hedge fund managers are still prevalent, many believe that operating in the region where they invest is a more sustainable business model. It puts them closer to where the assets are being invested, and immerses them in the region’s cultures, customs and languages. Locating not only distribution but research, operations and investment in the region is a significant strategic decision but one that can underline the fund manager’s intentions and focus activity.
Size does matter – but only in terms of ensuring that the fund has adopted the right strategy. Asian hedge funds tend to be smaller than their European and US counterparts: Asia has around 30% of the world’s hedge funds by number, but only about 7% by assets under management. This is especially challenging in Asia as there are increasing barriers to entry for new managers and high costs of doing business.
There is no universally accepted business model. It all depends on the fund manager’s size, strategy and other factors. Smaller fund managers will undoubtedly face some stiff challenges, but big managers have plenty to contend with as well. Knowing the market and investor expectations are key to building a sustainable business model, so size must be matched with focus and expertise.
There has been talk of consolidation being the panacea for many of the difficulties. Fund managers merging, or even just collaborating, can lead to cost savings in infrastructure and regulatory compliance. A degree of consolidation has happened already in the Asian hedge fund sector, but it has not been significant as yet.
Managing counterparty risk
An important component of a successful business model is the trusted counterparty. Hedge fund managers are rightly looking closely at the balance sheet strength and creditworthiness of their custodians, fund administrators and other financial counterparties because this is exactly what is now expected by investors. Managers need to make sure they are working with strong and competent providers who are not only able to deal with their concerns, but also ask them pertinent questions about their business.
Positioned for the future
With the right business model and trusted counterparties, hedge fund managers in Asia are well placed to face the challenges and take advantage of the opportunities. Exciting new markets are opening up, such as South Korea. The internationalisation of the renminbi and the recent Qualified Domestic Limited Partner (QDLP) initiative are China’s first considered steps to allow onshore hedge funds.
The challenges are manifold, but as the industry bounces back the hedge fund manager’s priorities are clear: to meet investor expectations on returns and risk mitigation and at the same time maintain a well-run organisation with a strong compliance culture and robust internal controls.