The current low interest-rate environment, combined with an abundant issuance of Asian corporate bonds, has set the stage for a comeback of credit hedge funds in the region.
Industry data provider Eurekahedge lists fixed income hedge funds as the second-best performing Asia strategy last year, with an average gain of 11.7%, behind event-driven funds, which returned 15.6%.
A chief reason behind this performance has been a renewed focus on credit amid a low interest-rate environment.
“Asian spreads are tight, but they’re still relatively attractive, particularly in relation to US high yield and US investment grade [bonds] on a ratings basis,” says David Walter, head of Asian research at Pacific Alternative Asset Management Company (Paamco).
Asian credit also compares well with the region’s volatile equity markets, says Lanny Lim, portfolio manager at fund-of-hedge-funds firm Sail Advisors. “It’s had far higher compound returns than the equity markets since the Asian crisis, and without a lot of volatility.”
The returns have filtered down to hedge fund managers. Several credit strategies that launched post-crisis had strong performance in 2010-12, ranging in the mid-teens, says Walter.
While market rallies have buoyed the performance of some long/short equity funds above those of credit strategies, the latter remain stable with single-digit returns in the first quarter of this year. “On risk-adjusted returns, they’ve been very good,” says Walter.
The stability and relatively low volatility has made credit an attractive hedge strategy for large players. US institutions are the biggest allocators to Asian hedge funds overall, with credit strategies appealing to insurers and pension firms, in addition to funds of funds, says Lim.
Credit strategies are divided into two camps, based on the liquidity of portfolios. The more liquid funds are invested in G7, sovereign or highly rated corporate names, with managers that “tend to be actively trading in and out of big-name issuers with high liquidity and tight spreads”, says Mark Wightman, global head of alternatives strategy at SunGard Financial Systems.
“Liquid credit strategies will typically offer investors monthly or quarterly liquidity with 30-45 days' notice,” notes Sukru Kesebi, head of Asia-Pacific hedge fund consulting at Deutsche Bank.
Liquid credit hedge fund managers in Asia include Saka Capital and Tahan Capital Management in Singapore and Hong Kong-based firms Prudence Investment Management and Serica Capital.
The less liquid funds have structures more akin to private equity vehicles, with portfolios in assets such as high-yield credit, distressed debt and private loans. They include newcomers Asia Research and Capital Management (ARCM) and Tor Investment Management, along with veteran distressed investor ADM Capital, all based in Hong Kong.
Less liquid strategies typically have one-year investor lock-ups with quarterly redemptions, notes Kesebi. “Investor-level gates are also not uncommon.”
While Asia’s credit market is still smaller and less mature than those in the US and Europe, issuance is strong. The Asian US dollar bond market alone has more than doubled over the past decade, says Lim at Sail, largely because of strong issuance out of China. “China is now a very significant part of Asian credit indices,” he notes.
About $23 billion in Asia ex-Japan, dollar-denominated, corporate investment-grade debt has been issued this year – matching the amount for all of 2012 and almost double the $14 billion in 2010, according to Dealogic.
The best hedge fund managers in the space have had several years of prior experience in trading Asian credit, either at investment banks or asset management firms, but there are not many of them in the region, say industry executives.
Walter at Paamco observes that there are a couple of large fund managers from overseas that are seeking to enter the Asian credit market. They will likely build out teams based in the region and hire from the small pool of locally based talent.
*A full version of this article will appear in the May magazine issue of AsianInvestor.