Hedge Fund Expert Explains Why Asia-Focused Firms Are Outperforming Market Benchmarks

A few days ago, Agecroft Partners founder and CEO Don Steinbrugge wrote an article titled “Why There's A Big Opportunity In Asia-Focused Hedge Funds.”

Asia-based, Asia-focused hedge funds offer great opportunities for investors nowadays; Steinbrugge told Benzinga in a follow-up interview. However, he suggested that we “dive a little bit deeper and examine some of the inefficiencies in the market” because, at the end of the day, the skill of a money manager rests on beating an index, beating the market, not on beating other funds.

What Hedge Funds Do Best

Only a handful of long/short equity managers in the U.S. have managed to consistently beat the S&P 500 SPY in recent years. On the other hand, many Asia-based long/short equity managers focusing on regional indexes like the iShares MSCI Pacific ex-Japan Idx (ETF) EPP have managed to beat their benchmarks by very large margins. Similar has been the case with China-focused funds, which have beat their market by roughly 10 percent per annum in recent years.

But, which factors are helping these Asia-based managers deliver such strong performances?

First and foremost is the volatility of the markets in Asia, Steinbrugge explained. One of the things that has hurt U.S. managers is the extremely low volatility, reflected by the iPath S&P 500 VIX Short Term Futures TM ETN VXX and the underlying VIX Index’s current levels, close to all-time lows. “If you don’t have a lot of volatility, you don’t have a lot of relative price movements between securities,” he said. The basic premise investors rely upon is to go long on stocks they think will do well and subsequently sell short those they anticipate to perform poorly. Following that line of thinking, in the absence of volatility, investors will be forced to wait very long times before those securities reach their sell or buy targets, he said. “In Asia, there is significant volatility. So, if you find a security you like a lot, it potentially will reach its target price much quicker and you can have higher turnover in your portfolio.”

The second thing that is very different about Asia when compared to the U.S. marketplace is that the former is dominated by retail investors, who are not as sophisticated as hedge funds — which dominate a very small portion of the market. “As a result of that, doing fundamental research on these companies, hedge funds can get an information edge over retail investors,” the expert told Benzinga, pointing out that getting such an advantage in the U.S. is extremely difficult.

Another element impacting the performance of Asia-focused hedge funds is the “greater rotation of industry leadership,” Steinbrugge continued. Taking China as an example: Until quite recently, its economy was dominated by “old economy industries” like steel; however, massive investments have helped these companies pivot to more current industries like tech and services. “When you large rotation of the industries like that, you are going to have winners and losers. For a long/short equity manager, it makes it easier to add value because you can find very good companies to buy, and you can also find very good companies to sell short that are going to get hurt during this rotation.”

Where In Asia

Before moving on, it’s important to clarify what the hedge fund industry calls Asia. Perhaps counter-intuitively, "Asia" excludes the Middle East but includes Australia, as well as Southeast Asian countries, India, China, Japan, Korea and Hong Kong.

Another way to outperform U.S. benchmarks by investing in this region is to realize what works in certain countries, Steinbrugge said. Is it a new type of grocery store? Is it a new type of restaurant? Is it some type of local product that can be replicated in a different market with a different company?

“Looking at what has worked really well in one country and trying to identify a company in another country that is replicating the same idea is a way to outperform the market. Also looking at companies in the same industry in different markets and comparing their relative strengths.”

The Macro Factor And Valuations

Finally, there’s a macroeconomic factor: Asia already produces 36 percent of the world’s GDP, and the IMF is forecasting approximately two-thirds of global growth over the next five years will come from that region. Nonetheless, only 4–5.5 percent of the $3 trillion in global hedge fund assets are allocated to these countries, Steinbrugge said.

Juxtaposing this to the fact that securities in Asia are valued at a significant discount to U.S.-traded stocks, it becomes clear that these markets offer larger opportunities to add value to funds’ portfolios.

Embracing Emerging Managers

Most of the Asia-focused hedge funds outperforming U.S. markets are based off Asian countries. “It is always better to be closer to where the investment opportunities are,” Steinbrugge explained. “It used to be that people were biased against Asia based managers because they weren’t viewed as having the same institutional quality. But today, these hedge funds have very large research teams; a lot of them are either Western-educated or the people running the firm have spun out of either large hedge funds or large investment banks and have very accomplished biographies.”

While restraining from naming any specific Asia-focused funds, Steinbrugge emphasized the vast number of options. In fact, just between Singapore and Hong Kong, there are more than 55 organizations that manage over $1 billion in assets.

The Risks

Last but not least, Steinbrugge highlighted the risks of investing in Asia-focused hedge funds.

“I think it’s important that investors have a diversified portfolio, and if they are going to allocate to Asia, they should limit what percentage they invest in Asia. If they are investing in a mutual fund or a hedge fund, over time it should experience higher volatility than investing in U.S. equities,” he explained. “But it also has the potential to generate higher returns long term than U.S. equities, so you have to take a long-term horizon when you allocate to Asia. I mean, if two-thirds of the world's growth is coming from Asia, it probably makes sense to have some part of your portfolio allocated to Asia.”

Other Asia-focused ETFs outperforming the S&P 500 this year include:

• Vanguard FTSE Pacific ETF VPL
• iShares MSCI South Korea Index Fund(ETF) EWY
• iShares MSCI Cntry Asa Jpn Idx Fnd ETF AAXJ
• iShares MSCI Taiwan Index (ETF) EWT
• iShares MSCI Philippines Investable EPHE
• iShares MSCI Indons Invstbl Mrkt Indx Fd EIDO
• Market Vectors Vietnam ETF. VNM

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Don Steinbrugge Explains Reinsurance: A Strategy That Helps Hedge Funds Remain Safe From Market Volatility

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Image Credit: Javier Hasse