Nikko Asset Management has entered an alliance with a global hedge fund service provider to launch a new offshore fund of hedge funds. Nikko already provides a range of alternative investments for its Japanese clients, but these are all onshore, yen-based strategies. Now the firm is looking to broaden its horizons and provide Japanese pension funds with a global hedge fund exposure, says Masafumi Hikima, president and CEO at Nikko AM in Tokyo.

Nikko's role will be gatekeeper for the clients and conducting asset allocation, while the US-based partner is charged with selecting the hedge fund managers. The partner's name will be announced soon.

The arrangement reflects the rapidly evolving Japanese market for alternative investments. "In the past, Japanese trust banks and other providers imported ready-made funds of funds," Hikima explains. "But we've moved to the second stage now, where we have tailor needs specifically for our Japanese clients."

The more sophisticated of Japanese pension funds are increasingly keen to not just let offshore gatekeepers provide products. Instead they want to scrutinize each constituent manager, to ensure it fits with their changing risk/return profiles.

"Many Japanese plan sponsors aren't prepared to have a strong opinion about asset allocation mixes in alternative investments," Hikima says. "They just provide gatekeepers with their target risk and target return. But they appreciate that investing in a fund of hedge funds is more than just doing the due diligence on mangers. They want to understand the industry trends and money flows within alternative investments. They want to see which strategies have the best expected returns, and want to know how to avoid the traps of overcapacity in certain strategies."

One example of how the Nikko product may differ from many offshore funds of hedge funds is a lower exposure to areas such as mortgage-backed securities arbitrage, which Hikima says has suffered from low liquidity and pricing problems recently. The exposure to global macro may be adjusted to account for a client's higher or lower toleration for risk.

Hikima believes the fund of funds approach will continue to be popular among Japanese pension funds. Only the very biggest funds have the research capacity to invest directly into single strategies, he reckons.

The new product will debut this month. Nikko AM already manages onshore convertible bond arbitrage funds, option arbitrage funds, long/short equity strategies and market-neutral equity strategies.