Why There's A Big Opportunity In Asia-Focused Hedge Funds

For the first time in several years, investors have begun expressing an interest in opportunities in Asia. Investors have shared increasing concerns about the high valuations of both the U.S. equity and fixed income markets (pushed further by the Trump rally in the U.S. equity markets).

In addition, as many U.S. and European based managers' performance has lagged, investors have looked to diversify their portfolios and enhance returns. Evidence of asset flows into a strategy or region usually takes about 9 to 12 months to materialize due to the lengthy due diligence period of most hedge fund investors. We expect to see data reflecting this shift toward Asia around the end of 2017 and into 2018.

The Asian hedge fund industry comprises approximately 4 percent-5.5 percent of the $3 trillion in global hedge fund assets based on data provided by two of the largest hedge fund databases. Asia is significantly underrepresented in most investors' portfolios, considering it produces approximately 36 percent of world GDP and the IMF expects Asia to contribute nearly two-thirds of economic growth in the next five years.

This forecasted disproportionate share of global GDP growth reflects a strong long-term trend driven by favorable demographics of a younger population and higher birth rates compared to western countries.

The under exposurer to Asian hedge funds has increased over the past couple of years, as investors shifted assets out of Asia and into North America and Europe in response to Asian equity markets lagging the performance of the S&P 500. However, this has also caused Asian equity valuations to look increasingly more attractive.

For example, comparing equity valuations and growth rates of the two largest economies earlier this year showed China's GDP growing at a 6.2 percent rate versus the U.S.'s GDP growth rate of 2.3 percent, while China PE ratios were approximately 8.3 versus the S&P 500 PE of 18.3.

This disparity in valuation is not limited to just the equity markets, and can be seen in other asset classes as well. Over the past 10 years we have seen the Asian hedge fund industry become more diversified from a strategy perspective. In addition to long/short equity, hedge funds have employed distressed debt, activist, convertible bond arbitrage, credit, quantitative, muti-strategy, and market neutral equity strategies, among others.

In addition to more attractive valuations, Asian markets also offer more inefficiencies in security selection, because only a small fraction of the hedge fund industry focuses on these opportunities. It is difficult to find U.S. managers that have outperformed the S&P 500. In contrast, there are many Asian managers that have outperformed their benchmarks by wide margins, adding significant alpha.

It is not a surprise that Asian based managers are underrepresented in U.S. portfolios given the physical distance and the difficulty in obtaining information on these managers. The good news is that a large number of Asian managers are concentrated in two cities, Hong Kong and Singapore. This makes it fairly easy to meet with many of the top managers in a short period of time.

Preqin's database shows there are 57 hedge funds with at least $1 billion in assets under management in Asia, with 61 percent located in Hong Kong and 14 percent located in Singapore. Of the remaining 25 percent, a number of them also have offices in one of these two cities. Given the opportunities, most large allocators to hedge funds should consider traveling to these cities once or twice a year.

In conducting our own search for Asian managers, we have historically found information on Asian based managers to be less readily available than those based in the U.S. and Europe. For example, only about 30 percent of the Asian-based hedge funds we researched had updated information in one of the major hedge fund data bases.

In order to find the highest quality managers in Asia, investors should not only leverage multiple hedge fund data bases, but also speak with prime brokers, review several hedge fund trade publications, spend time searching on the internet and speak with other investors. Ultimately for those willing to put in the work, we believe it will identify a number of very high quality hedge funds they would not otherwise come across.
 

Don is the Founder and Managing Partner of Agecroft Partners, a global hedge fund consulting and marketing firm. Their third annual Gaining The Edge summit is November 2-3 in New York City.