Strong performance by Japan-focused hedge fund managers has sparked investor interest in the past few months.

Japanese funds returned an average of 21.7% in the six months through March, according to data provider Eurekahedge, with managers telling AsianInvestor they’re seeing a recent uptick in investor meetings.

“The amount of investor enquiries into what we’re doing in Japan, and how we’re generating returns, hasn’t been this high since 2005,” says David Baran, co-chief executive officer of Tokyo-based Symphony Financial. The firm’s SFP Value Realization Master Fund, a Japan event-driven strategy, has returned 44% in the three months to end-March.

“We are beginning to see a lot of investor interest,” says Masa Yanagisawa, head of the hedge fund capital group for Deutsche Bank in Japan.  So far it has mostly stemmed from European family offices, he notes, adding that some have already allocated capital. 

“With a few exceptions, we haven’t seen substantial inflows from institutional investors yet, but they tend to have a longer due diligence process,” notes Yanagisawa.

Fresh capital inflows would give a much-needed boost to the Japanese hedge fund sector, which had 83 strategies running a total of $14.7 billion in AUM as of the end of March. It is less than half of the $39 billion in peak assets managed in April 2006, according to data provider Eurekahedge, and only a fraction of the $2 trillion in industry assets managed globally.

“Japan is the world’s third-largest economy, but is easily the second-widest and second-deepest stock market,” says Ed Rogers, the Tokyo-based chief executive of fund-of-hedge-fund advisory Rogers Investment Advisors.  

However, the sector has been slower to stage a post-crisis recovery than other hedge fund markets in Asia. 

A massive earthquake and tsunami in the country’s northwest in 2011 led to volatile markets. The following year, just when it seemed that the markets had stabilised, came the revelation that Tokyo-based alternatives asset manager AIJ Investment Advisors lost more than $1 billion in client money running a Ponzi scheme.

Although Japan funds weathered these volatile markets well – Japan managers fell 1.35% in 2011, compared with a 12% drop for Asia-Pacific ex-Japan funds and an 11% decline on the Topix – the AIJ scandal shook investor confidence, and Japanese institutions remain wary of investing in hedge funds, say industry executives.

“You still can’t get a Japanese pension fund to allocate to the sector,” says one.

There are also some seasoned investors overseas who are not yet convinced that Japan has ended its long run of stagnant economic growth. “There will be some that still won’t participate,” notes an executive. 

However, for those seeking to profit from directional gains in a single-market bull run this year, Japan would seem to be an obvious place from which to tap momentum-driven performance.

In the hedge fund sector, Japanese long/short equity funds – which are typically long-biased – are expected to be among the best performing strategies, along with long-only vehicles.

Managers focusing on small- and mid-cap stocks in particular have been able to benefit from greater market liquidity.

A number of long-biased managers who specialise in mid-caps have performed very well this year, says Deutsche’s Yanagisawa. Some have had steady monthly gains of 2-3%, potentially putting them on track for a full-year return of 20%+.

The resilience of Japanese hedge funds amid 2011’s downturn and strong gains from this year’s bull run are evidence of highly adaptable managers who can perform well in both good and bad conditions, industry executives argue.

Yet some still question how long the market’s upward momentum will last. Japan’s economic boom in the 1980s was followed by weak economic growth for much of the past two decades.

Rogers takes the view that the next two-to-four years of Abenomics will be a “renovation process to undo two decades of deflation”, with even greater investor participation in the market after the second year.

*A full version of this article will appear in the May print edition of AsianInvestor