It is not news to anyone that for the last few years the Japanese investment environment has been extremely difficult to say the least. The opportunities for making traditional money in Japan have been next to nothing and the concurrent downturn in the global markets since late 2000 has only exacerbated the problems facing mainstream Japanese investors. The lack of absolute returns is a problem facing both retail and institutional investors across the board in Japan.

The institutional investors, especially pension funds are starting to reach a critical point in their conservative history. As we are now approaching the 4th generation since WWII the pension funds are starting to feel the pressure of ever increasing draw downs from the ageing Japanese population. This is not a situation that will be easily reversed and coupled with the fact that they have now recorded their 3rd straight year of negative returns with 2002 being the biggest at –12%, corporate and government pension funds are beginning to wake up to the fact that their current investment strategy is simply unsustainable.

Japanese retail investors have also had to bear the brunt of these losses as the lack of a comprehensive system of industry watchdogs has seen an environment open to systematic abuse by many domestic brokers. Retail investors have lost money in all markets and as a result are now increasingly wary of any investment idea. However, with interest rates nearly at zero they cannot afford to simply keep cash on deposit especially if the economy beings to reverse its deflationary trend. With the stock market bouncing off 20 year lows, bond yields not much better and overseas markets in similar shape there is precious little choice available.

Real Estate Investment Trusts (REIT) with a 4 – 5% dividend yield were originally pitched to retail investors but are being aggressively bought by institutions and regional banks. Mizuho Bank has begun marketing a new fund investing in securitised auto loans with an expected yield of a mere 0.3% yet it expects the annual market to grow between JPY500 Billion to JPY1 Trillion. While desperation may be too strong a word, there is clearly a need for solid investment opportunities with absolute returns now more than ever.

There is without doubt an increasing awareness of Hedge Fund Investments in Japan among both the professional and retail investment community, even to the point that we have noticed articles on Hedge Fund Investing in a website targeting Japanese housewives. A Rating and

Investment Information Inc. survey concluded that on average corporate pension funds allocate 1.3% of their assets to alternative investments. Some corporates have announced however that they have and will continue to increase alternative asset allocations – TDK Corp recently stated they have 5% of their pension assets allocated to domestic long/short strategies that have posted positive returns which are offsetting the negative performance of the rest of their portfolio.

Both domestic and foreign Asset Managers are beginning to roll out more Alternative Investment Products (AIP) such as leveraged hedge funds, REITs and Private Equity Funds, targeting pension plans. UFJ Trust Bank is planning a Fund of Hedge Funds, Sumitomo Mitsui A.M. is planning to increase its AIP allocation from Y32 Billion to Y50 Billion. Sumitomo Trust & Banking Company meanwhile increased its allocation of funds to alternative investments by tenfold between 2001 and March 2003 and it currently now stands at Y180 Billion of which 70% is invested in hedge funds.

However, all is not as rosy for the hedge fund industry in Japan as it may seem. There is still a long way to go before single strategy hedge funds are seen as an acceptable investment vehicle for the majority of investors in Japan. Most of hedge fund investments to date have been through US gatekeepers into fund of hedge funds. This diversification of risk is always much easier to justify than a punt on a single manager regardless of the pedigree.

Shinsei Bank recently teamed up with Investor Select Advisers and CDC IXIS Capital Markets to create and market a Principal Protected Note for a fund of hedge funds. They were remarkably successful raising US$70 million in 3 tranches over 6 months. We think that this is where the main hedge fund investment growth opportunities lie for the immediate future in Japan and Asia. The ability to offer the chance to invest in a high yield hedge fund vehicle and guarantee your principal would seem an ideal opportunity for the absolute return starved conservative Japanese investment community.

There are of course still many peripheral issues to be catered for and this kind of product is by no means a failsafe nor guaranteed to succeed but it would seem to have far more chance than a straight hedge fund investment especially given the conservative nature of the Japanese financial institutions.

Capital guaranteed structured products with a fund of hedge fund underlying is by no means new in the US and Europe but they are gaining popularity. Man Group plc recently launched another such product and was able to raise more than GBP460 Million. It is easy to see that if the regulatory environment is cleared up and hedge funds continue to outperform mutual funds and indexes, these kind of structured products could become the standard type of retail investment product in the future.

Daiko Henjo

A system set up by the government whereby corporate pension funds hand over their assets to a government fund for investment. These assets could only be handed over in cash which adversely affected the stock markets due to the expected and actual sell off of stock holdings. Daiko Henjo is now winding up and the question on everyone’s lips is what will be done with all the pooled resources. There have been whispers that a significant portion of these funds will be allocated to high yield alternative investments. One are of particular interest is that of private equity. Corporate pension funds have been unable to go down this avenue due to a lack of protection of any kind and lack of funds they could safely commit to such a high risk/reward profile. If the government fund were to invest then these pension funds would finally have the ability to get involved while also being able to enjoy the buffer of pooled resources and government support.

This could be a large opportunity for hedge funds, either through a gradual acceptance of hedge funds or fund of hedge funds as an asset class by the government, or investment in distressed hedge funds focusing on corporate restructuring in Japan.

Teguchi

The Tokyo Stock Exchange reporting system, otherwise known as the Teguchi, which posted a daily summary of broker activity was closed in July this year. The driver behind this move was Fidelity of the US. It is still a little early to judge the full impact of this change, however, one thing is for certain, this does give large funds and hedge funds the ability to make big anonymous plays in the market much more easily.

A side effect will certainly be the demise of the weaker brokers who relied on the necessity for anonymity which forced big players to spread out their orders. This was often the only reason they received any business at all. Whether or not this will lead to an increase in market volume and liquidity per se is something that will have to be assessed at a later date.

New Start-Ups

We are beginning to see a few stirrings after a sleepy start to the year with regard to new hedge funds. We expect to see a couple of large, high profile foreign manager start-ups in Japan by year end. What is more encouraging though are signs that there may be more and more Japanese manager start-ups in the near future. We believe that this will have a very positive impact on the hedge fund industry as a whole and are actively encouraging Japanese traders to pursue their ideas to fruition.

We are confident that once enough Japanese managers start to break the mould and establish their own operations in Japan the domestic hedge fund industry will be able to proceed rapidly with much more domestic institutional and private investment pouring in.

This entry was posted on Friday, October 3rd, 2003 at 7:23 pm.

It is not news to anyone that for the last few years the Japanese investment environment has been extremely difficult to say the least. The opportunities for making traditional money in Japan have been next to nothing and the concurrent downturn in the global markets since late 2000 has only exacerbated the problems facing mainstream Japanese investors. The lack of absolute returns is a problem facing both retail and institutional investors across the board in Japan.

The institutional investors, especially pension funds are starting to reach a critical point in their conservative history. As we are now approaching the 4th generation since WWII the pension funds are starting to feel the pressure of ever increasing draw downs from the ageing Japanese population. This is not a situation that will be easily reversed and coupled with the fact that they have now recorded their 3rd straight year of negative returns with 2002 being the biggest at –12%, corporate and government pension funds are beginning to wake up to the fact that their current investment strategy is simply unsustainable.

Japanese retail investors have also had to bear the brunt of these losses as the lack of a comprehensive system of industry watchdogs has seen an environment open to systematic abuse by many domestic brokers. Retail investors have lost money in all markets and as a result are now increasingly wary of any investment idea. However, with interest rates nearly at zero they cannot afford to simply keep cash on deposit especially if the economy beings to reverse its deflationary trend. With the stock market bouncing off 20 year lows, bond yields not much better and overseas markets in similar shape there is precious little choice available.

Real Estate Investment Trusts (REIT) with a 4 – 5% dividend yield were originally pitched to retail investors but are being aggressively bought by institutions and regional banks. Mizuho Bank has begun marketing a new fund investing in securitised auto loans with an expected yield of a mere 0.3% yet it expects the annual market to grow between JPY500 Billion to JPY1 Trillion. While desperation may be too strong a word, there is clearly a need for solid investment opportunities with absolute returns now more than ever.

There is without doubt an increasing awareness of Hedge Fund Investments in Japan among both the professional and retail investment community, even to the point that we have noticed articles on Hedge Fund Investing in a website targeting Japanese housewives. A Rating and

Investment Information Inc. survey concluded that on average corporate pension funds allocate 1.3% of their assets to alternative investments. Some corporates have announced however that they have and will continue to increase alternative asset allocations – TDK Corp recently stated they have 5% of their pension assets allocated to domestic long/short strategies that have posted positive returns which are offsetting the negative performance of the rest of their portfolio.

Both domestic and foreign Asset Managers are beginning to roll out more Alternative Investment Products (AIP) such as leveraged hedge funds, REITs and Private Equity Funds, targeting pension plans. UFJ Trust Bank is planning a Fund of Hedge Funds, Sumitomo Mitsui A.M. is planning to increase its AIP allocation from Y32 Billion to Y50 Billion. Sumitomo Trust & Banking Company meanwhile increased its allocation of funds to alternative investments by tenfold between 2001 and March 2003 and it currently now stands at Y180 Billion of which 70% is invested in hedge funds.

However, all is not as rosy for the hedge fund industry in Japan as it may seem. There is still a long way to go before single strategy hedge funds are seen as an acceptable investment vehicle for the majority of investors in Japan. Most of hedge fund investments to date have been through US gatekeepers into fund of hedge funds. This diversification of risk is always much easier to justify than a punt on a single manager regardless of the pedigree.

Shinsei Bank recently teamed up with Investor Select Advisers and CDC IXIS Capital Markets to create and market a Principal Protected Note for a fund of hedge funds. They were remarkably successful raising US$70 million in 3 tranches over 6 months. We think that this is where the main hedge fund investment growth opportunities lie for the immediate future in Japan and Asia. The ability to offer the chance to invest in a high yield hedge fund vehicle and guarantee your principal would seem an ideal opportunity for the absolute return starved conservative Japanese investment community.

There are of course still many peripheral issues to be catered for and this kind of product is by no means a failsafe nor guaranteed to succeed but it would seem to have far more chance than a straight hedge fund investment especially given the conservative nature of the Japanese financial institutions.

Capital guaranteed structured products with a fund of hedge fund underlying is by no means new in the US and Europe but they are gaining popularity. Man Group plc recently launched another such product and was able to raise more than GBP460 Million. It is easy to see that if the regulatory environment is cleared up and hedge funds continue to outperform mutual funds and indexes, these kind of structured products could become the standard type of retail investment product in the future.

Daiko Henjo

A system set up by the government whereby corporate pension funds hand over their assets to a government fund for investment. These assets could only be handed over in cash which adversely affected the stock markets due to the expected and actual sell off of stock holdings. Daiko Henjo is now winding up and the question on everyone’s lips is what will be done with all the pooled resources. There have been whispers that a significant portion of these funds will be allocated to high yield alternative investments. One are of particular interest is that of private equity. Corporate pension funds have been unable to go down this avenue due to a lack of protection of any kind and lack of funds they could safely commit to such a high risk/reward profile. If the government fund were to invest then these pension funds would finally have the ability to get involved while also being able to enjoy the buffer of pooled resources and government support.

This could be a large opportunity for hedge funds, either through a gradual acceptance of hedge funds or fund of hedge funds as an asset class by the government, or investment in distressed hedge funds focusing on corporate restructuring in Japan.

Teguchi

The Tokyo Stock Exchange reporting system, otherwise known as the Teguchi, which posted a daily summary of broker activity was closed in July this year. The driver behind this move was Fidelity of the US. It is still a little early to judge the full impact of this change, however, one thing is for certain, this does give large funds and hedge funds the ability to make big anonymous plays in the market much more easily.

A side effect will certainly be the demise of the weaker brokers who relied on the necessity for anonymity which forced big players to spread out their orders. This was often the only reason they received any business at all. Whether or not this will lead to an increase in market volume and liquidity per se is something that will have to be assessed at a later date.

New Start-Ups

We are beginning to see a few stirrings after a sleepy start to the year with regard to new hedge funds. We expect to see a couple of large, high profile foreign manager start-ups in Japan by year end. What is more encouraging though are signs that there may be more and more Japanese manager start-ups in the near future. We believe that this will have a very positive impact on the hedge fund industry as a whole and are actively encouraging Japanese traders to pursue their ideas to fruition.

We are confident that once enough Japanese managers start to break the mould and establish their own operations in Japan the domestic hedge fund industry will be able to proceed rapidly with much more domestic institutional and private investment pouring in.

This entry was posted on Friday, October 3rd, 2003 at 7:23 pm.