We are seeing a greater shift towards general acceptance and interest in Japanese investment in hedge funds. This is hardly surprising given the current market situation where the only investments generating serious absolute returns appear to be hedge funds.
The obvious attraction of hedge funds is however tempered by reservations that have only been reinforced by the recent Eifuku experience. Recent surveys have shown that despite these reservations, interest and actual investment in hedge funds by the Japanese investment community is increasing. Japanese Life insurers in particular have been looking to increase their alternative investment allocations.A survey carried out by AIMA last year discovered that with about US$6 billion invested in Asia Pacific Strategies, Tokyo has considerably more than in any global other financial center.

Hedge Funds  

On the trading side it is getting increasingly difficult for traditional hedge funds to profit in the Japanese market. M&A activity has yet to gain any momentum this year offering few pure Risk Arbitrage opportunities. There are precious few new Convertible Bond issues constraining CB Arbitrage strategies. The lack of liquidity in the market means that the position sizes of some of the larger hedge funds are their own worst enemy making even Equity Long/Short trades difficult. Add to this the continued pressure on short selling being exerted by the watchful eye of the FSA. We are however still seeing consistent high returns in Index and Index Options volatility traders. There also appear to be opportunities in the Distressed Debt field as well as Equity Long/Short depending on position size and the quality of research. The most recent example of these difficulties is the effective closure of Penta citing a lack of liquidity in the market. What remains of Penta will shift part of its focus to the rest of Asia highlighting another recent trend. With market volumes ever decreasing, more funds and institutions are including Japan in an all Asia strategy.

Japanese Environment

On the regulatory side the Japanese government does not appear to be taking an overtly adverse stance to hedge funds. In fact they are being seen to encourage hedge funds that do not have direct equity short-selling strategies. Short selling of stocks is a politically sensitive issue in Japan. There appears to be some recognition of the value a hedge fund can bring to the financial markets in Japan. We are also starting to see an increase in the number of hedge fund offices physically located in Japan. With the current low property prices, available talent pool and increase in prime brokerage services available, setting up an office in Japan is becoming more attractive and more competitive to other Asia centers than ever before.

Investors

Despite an increase in interest, traditional investment barriers are still being encountered. The large Japanese institutions still tend to require a lengthy track record (2-3 years), a certain amount of assets under management and a manager with an excellent pedigree before they will consider any serious investment. The trend remains that once a hedge fund is seen to be acceptable many institutions will suddenly want to invest. There are rumblings of change regarding the strictness of these criteria and the almost exclusive use of US ‘gatekeepers’. We are confident that once the barriers come down there will be a flood of Japanese investment into hedge funds within the next 12 to 18 months. The impression has been that once Japanese institutions do invest their investment tends to be ‘sticky’. This does not appear to be a hard and fast rule anymore. With so much pressure on returns, we are finding that even the long-term pension funds are jittery, pulling their money out after a few months of bad returns. The rather surprising word on the street is that domestic managers are starting to look overseas for any anchor investment first. The fact still remains however, that seed financing in Japan when it does occur tends to be large. Prime BrokerageThe area of prime brokerage is starting to get quite active in Japan with a few late entrants aggressively marketing themselves. It appears that the volume approach of taking on many new hedge fund clients in the hope of finding one giant future revenue generator is a strategy that has not paid off. This is leading to a more discerning approach in the way prime brokers take on new clients. Some have capital requirements while others will look at overall strategy and motive behind start-ups in assessing suitability. The dominance of the big two titans, Goldman Sachs and Morgan Stanley is gradually being eroded as hedge funds start to see the benefits of adding a second prime broker service. The new entrants are also creating more competition for fees. What this all means for hedge funds is that while it may be more difficult to find a first class prime broker in the start-up phase, once critical mass has been achieved then the options are certainly more attractive than previously available. Overall there appears to be a general realization that there is not enough choice being offered to potential new hedge funds among service providers and that there is a general lack of information widely available. In Japan there is definitely growing interest in Hedge Funds among institutional and retail investors but this is coupled with a greater sense of caution as to what kind of strategy and which manager to invest in. The prime brokers are partly executing this initial filtering process. For start-up managers a clearly defined strategy that has a positive edge over the competition, a good track record and a thorough infrastructure set-up will go a long way to addressing the requirements of any seed investor.

This entry was posted on Monday, May 12th, 2003 at 3:04 pm.

We are seeing a greater shift towards general acceptance and interest in Japanese investment in hedge funds. This is hardly surprising given the current market situation where the only investments generating serious absolute returns appear to be hedge funds.
The obvious attraction of hedge funds is however tempered by reservations that have only been reinforced by the recent Eifuku experience. Recent surveys have shown that despite these reservations, interest and actual investment in hedge funds by the Japanese investment community is increasing. Japanese Life insurers in particular have been looking to increase their alternative investment allocations.A survey carried out by AIMA last year discovered that with about US$6 billion invested in Asia Pacific Strategies, Tokyo has considerably more than in any global other financial center.

Hedge Funds  

On the trading side it is getting increasingly difficult for traditional hedge funds to profit in the Japanese market. M&A activity has yet to gain any momentum this year offering few pure Risk Arbitrage opportunities. There are precious few new Convertible Bond issues constraining CB Arbitrage strategies. The lack of liquidity in the market means that the position sizes of some of the larger hedge funds are their own worst enemy making even Equity Long/Short trades difficult. Add to this the continued pressure on short selling being exerted by the watchful eye of the FSA. We are however still seeing consistent high returns in Index and Index Options volatility traders. There also appear to be opportunities in the Distressed Debt field as well as Equity Long/Short depending on position size and the quality of research. The most recent example of these difficulties is the effective closure of Penta citing a lack of liquidity in the market. What remains of Penta will shift part of its focus to the rest of Asia highlighting another recent trend. With market volumes ever decreasing, more funds and institutions are including Japan in an all Asia strategy.

Japanese Environment

On the regulatory side the Japanese government does not appear to be taking an overtly adverse stance to hedge funds. In fact they are being seen to encourage hedge funds that do not have direct equity short-selling strategies. Short selling of stocks is a politically sensitive issue in Japan. There appears to be some recognition of the value a hedge fund can bring to the financial markets in Japan. We are also starting to see an increase in the number of hedge fund offices physically located in Japan. With the current low property prices, available talent pool and increase in prime brokerage services available, setting up an office in Japan is becoming more attractive and more competitive to other Asia centers than ever before.

Investors

Despite an increase in interest, traditional investment barriers are still being encountered. The large Japanese institutions still tend to require a lengthy track record (2-3 years), a certain amount of assets under management and a manager with an excellent pedigree before they will consider any serious investment. The trend remains that once a hedge fund is seen to be acceptable many institutions will suddenly want to invest. There are rumblings of change regarding the strictness of these criteria and the almost exclusive use of US ‘gatekeepers’. We are confident that once the barriers come down there will be a flood of Japanese investment into hedge funds within the next 12 to 18 months. The impression has been that once Japanese institutions do invest their investment tends to be ‘sticky’. This does not appear to be a hard and fast rule anymore. With so much pressure on returns, we are finding that even the long-term pension funds are jittery, pulling their money out after a few months of bad returns. The rather surprising word on the street is that domestic managers are starting to look overseas for any anchor investment first. The fact still remains however, that seed financing in Japan when it does occur tends to be large. Prime BrokerageThe area of prime brokerage is starting to get quite active in Japan with a few late entrants aggressively marketing themselves. It appears that the volume approach of taking on many new hedge fund clients in the hope of finding one giant future revenue generator is a strategy that has not paid off. This is leading to a more discerning approach in the way prime brokers take on new clients. Some have capital requirements while others will look at overall strategy and motive behind start-ups in assessing suitability. The dominance of the big two titans, Goldman Sachs and Morgan Stanley is gradually being eroded as hedge funds start to see the benefits of adding a second prime broker service. The new entrants are also creating more competition for fees. What this all means for hedge funds is that while it may be more difficult to find a first class prime broker in the start-up phase, once critical mass has been achieved then the options are certainly more attractive than previously available. Overall there appears to be a general realization that there is not enough choice being offered to potential new hedge funds among service providers and that there is a general lack of information widely available. In Japan there is definitely growing interest in Hedge Funds among institutional and retail investors but this is coupled with a greater sense of caution as to what kind of strategy and which manager to invest in. The prime brokers are partly executing this initial filtering process. For start-up managers a clearly defined strategy that has a positive edge over the competition, a good track record and a thorough infrastructure set-up will go a long way to addressing the requirements of any seed investor.

This entry was posted on Monday, May 12th, 2003 at 3:04 pm.