Asian hedge fund allocations appear to be picking up from a low base as mainstream markets turn more volatile, with Korean institutional investors among the latest to heed the siren's call, despite relatively weak recent returns.
Korea Post Insurance (KPI) announced earlier this month that it would be looking for overseas hedge fund managers or financial institutions to oversee an additional 50% allocation to their hedge fund investment pool.
KPI is aiming to add around 15 funds with a total of W100 billion ($93.4 million), a spokesman for the group said, increasing its hedge fund investment pool to $280 million.
The move stands out in a country where the alternatives asset class has traditionally not been a significant component of institutional investor portfolios. Hedge fund mandates just haven’t been active in the last couple of years in Korea, Elizabeth Oh, head of investments advisory for Korea at Mercer, told AsianInvestor, citing "a legacy of poor performance relative to equities, high fees, and low transparency.”
In 2017, Korean hedge fund mandates had returns of 13.35%, the second-lowest among the Asia-Pacific groupings of hedge funds data provider Eurekahedge. Only Japanese hedge funds had lower returns, at 13.11%. Based on three-year and five-year annualised returns, Korea ranked last, with 2.32% and 5.03% returns, respectively. By comparison, the MSCI Korea index returned 47.8% in 2017 in what was a stellar year for stock markets generally.
However, attitudes towards hedge funds may be shifting in Korea due to changing market conditions in the first quarter of 2018, especially with strategies that can thrive in periods of volatility.
“As we begin to move from quantitative easing to quantitative tightening, they are seeing positive signs more recently for hedge fund alpha,” Oh said, noting the shift in monetary conditions as the Federal Reserve, especially, raises US interest rates and slowly begins to reverse its asset-buying programme.
Korean institutional investors had $1.65 trillion in hedge fund assets under management as of the end of the first quarter in 2018, up from $1.55 trillion at the end of 2017, according to alternative assets data provider Preqin. In percentage terms the average allocation to hedge funds was also up slightly, from 2.5% to 2.6%.
“In the current market situation with increasing volatility, equity long/short and event-driven strategies have been more interesting for hedge fund investors,” Oh said. Korean investors are also looking to get downside protection in the portfolio through Commodity Trading Advisors (CTA) strategies, she added.
A CTA fund is a hedge fund that trades in futures contracts, taking various long and short positions based on momentum indicators.
This uptick in Korean interest around hedge funds is part of a broader Asian trend as equity markets experienced volatility earlier this year and fixed income investments face rising rates and unattractive credit spreads, Damien Tan, managing director at investment consultancy Cambridge Associates, said.
“We do see that Asian investors are slowly but steadily thinking more seriously about at least maintaining their hedge fund allocation, and then increasing it to provide portfolio diversification, given the challenges in equities and bonds,” Tan told AsianInvestor.
Asian institutional investors are definitely shifting towards hedge funds, Carlyon Knight-Evans, assurance asset management partner at consultancy PwC, agreed. “We are seeing hedge funds specifically getting larger allocations from institutional investors,” he told AsianInvestor.
A January 2018 survey by BlackRock showed 20% of Asian institutional investors wanted to increase their hedge fund allocations, compared to 15% who said they wanted to decrease them. The same survey conducted the year before showed 28% of Asian institutional investors wanted to decrease hedge fund allocations.
In December 2017, Japan Post Bank said that they would bump up their hedge fund investments as part of its plan to boost its $7 billion alternatives assets allocation by a factor of almost 10.
STRATEGIES AND TYPES
Institutional investors across Asia use multiple hedge fund strategies, said Tan.
“The institutional investors we work with are fairly diversified in their hedge fund portfolios and would invest in different hedge fund strategies, including long/short equity, global macro, event-driven, credit and multi-strategy hedge funds,” he said.
The performance of these strategies is cyclical, Tan added, noting that event driven strategies did well in 2016 and 2017, after challenging years in 2014 and 2015.
Asian institutional investors are also looking to invest in hedge funds overseas, Knight-Evans said.
“There’s often for hedge funds a need for diversification geographically, so in some way the Asian investors are more likely to be looking to deploy assets at hedge funds in a more global or European and US mandate,” he said.
Asian institutional investors who are new to investing in hedge funds may use funds of hedge funds (FOHFs), but in general that way of allocating capital to hedge funds is declining, Cambridge Associate’s Tan said. “Those institutions who are large enough, they generally do try to go into hedge funds directly, rather than through funds of funds,” he said.
The smaller investors would be the ones who are still using the fund of hedge funds approach, said Tan, because they don’t have a big enough allocation to have a sufficiently diversified pool of hedge fund managers.
FOHFs, though, are attracting some attention in Korea.
“They’re using FOHFs, especially in the initial stage of hedge fund investments or to diversify hedge fund portfolios,” Mercer’s Oh said. Korean investors are especially attracted to FOHFs due to knowledge transfer and portfolio diversification capabilities, she said.
In general, Korean institutional investors view hedge funds as a way to improve the risk-to-return proposition by diversifying the risk in their portfolios. “By introducing new return drivers, the total portfolio relies less on the direction of capital markets and improving risk-adjusted performance with low volatility,” Oh said.
KPI’s 2017 AUM was $42.3 billion, according to our latest AI300, ranking them 129th out of the 300 largest asset owners in Asia Pacific in 2017, and number 12 in Korea. As one of the bigger institutional investors, their view towards hedge funds should have an impact on other Korean investors, in both FOHF and single hedge fund investments.
For more insights on investing in Korea, AsianInvestor is hosting its Korea Institutional Investment Forum in Seoul on June 20. For more details, visit the website or contact Terry Rayner via email or on +852 31751963.