Appetite returning for Asia-focused hedge funds

Interest in Asia-focused hedge funds is picking up among institutional investors, spurred by the strong recent performance of India and China strategies and modest hedge fund inflows generally, but any idea of a full-scale revival remains premature. Such is the overall view of industry experts as they noted the encouraging trend seen so far this year.  

“We see North European, Canadian, smaller US pension funds and a few Japanese institutions showing interest in Asian strategies,” Shirin Ismail, head of alternatives at Singapore's Fullerton Fund Management, told AsianInvestor. 

Momentum has picked up modestly compared with last year, she said, perhaps because some institutions are looking to diversify away from their heavy fixed income or credit allocations on the traditional/passives side.

Adrian Worth, a manager research consultant at Mercer, agreed that flows from the US and Europe into Asia-focused funds had been growing as institutions looked to diversify their portfolios.

Industry data confirmed the trend. Asia hedge funds saw net inflows of $2.3 billion in the first six months of 2017 compared with outflows of $3.4 billion for the whole of 2016, said Mohammad Hassan, Singapore-based head analyst at Eurekahedge.

Assets under management at Asia-focused hedge funds grew by $8.1 billion in the first half of this year, with $5.8 billion of this accounted for by performance-based gains, Eurekahedge data shows.

But then investor allocations to hedge funds generally have turned turned positive over this period, with those in North America seeing inflows of $39.5 billion and in Europe drawing in $11.5 billion, Hassan said.

China, India lead gains

In Asia, performance gains in China- and India-focused funds seem to be leading the upswing in investor interest.

According to the HFR Asian Hedge fund Industry Report released on August 4, the HFRX India Index posted an increase of 26.6%, beating the benchmark Sensex 30 index by over 1,000 basis points in the six months to June.

Chinese hedge funds also extended gains despite rising political tensions on the neighbouring Korean peninsula, with the HRFX China Index climbing 16.2% over the same period – higher than the gains seen for Chinese equities, according to the report.

Overall, the Asia ex-Japan index gained 15% in the first half of 2017 – the best performers on a regional basis.

Fullerton’s Ismail continues to like emerging markets and Asia, which she said were still underpinned by a robust economic backdrop and favourable capital trends.

“While we are cautious at current levels, we favour strategies that take advantage of both fundamentals and flows such as Asian equity long/short or long-bias with some thoughtful tactical shorts for protection when volatility picks up,” she said.

Within equities, she favours event-driven strategies, both for Asian and global markets, while she likes arbitrage strategies in fixed income.

In a Credit Suisse investment monthly outlook report issued in July, Stefan Graber, head of commodities strategy, said he maintained a positive outlook on hedge funds while favouring a balanced-style allocation.

“Tactical styles should be able to manage a potential rise in financial market volatility, while relative-value and fundamental strategies continue to benefit from the stable macroeconomic backdrop.”

Tough to track

Despite the seemingly positive trends, the available data on hedge funds is not always comprehensive. A good portion of the flows remains unreported, so it's not always clear what the actual trends are, some industry observers noted.

At this point it does seem like the large outflows have stopped, although it remains unclear when the large inflows will return.

In the past decade, hedge funds globally have come under severe pressure over their high fees and poor performance. Several high-profile hedge funds, including Och-Ziff Capital Management and Tudor Investment, have reduced their fees in recent years in a bid to quell investor discontent and boost AUM growth.

According to Eurekahedge, the average management fee for hedge funds globally has dropped from 1.68% of assets in 2007 to 1.27% in 2017.

The biggest obstacle to higher hedge fund allocations, however, is likely to be the relatively better performance of other assets.

Traditional Asian equities, for instance, as represented by the MSCI Asia ex-Japan index, are up 29.38% in the year to July-end. Even passive funds hugging this benchmark have gained more than hedge funds.

So despite the diversification benefits, investment experts don't expect to see a big pile-up in hedge fund assets in the near term.

Cautious optimism

Still, after a moderately positive first half of the year, industry experts remain cautiously optimistic about the outlook for the rest of the year.

There are risks looming on the horizon such as a potential revival in US dollar strength, a pick up in US inflation, and faster-than-anticipated US interest rate hikes, all of which could impact capital flows to Asian markets and hedge funds, said Eurekahedge’s Hassan. 

A hedge fund industry asset flow report released on July 21 by eVestment said the indications of interest in China-focused strategies seen in May mostly disappeared in June, although there were products that attracted new assets. 

This is an indication of how fragile investor sentiment remains. So perhaps it’s not time for the hedge fund industry to start celebrating just yet.