Japanese hedge fund managers are finding it difficult to raise money, say industry participants. According to Eurekahedge, Japanese hedge fund assets rose $11 billion from $29 billion to $40 billion over 2006. Although this is a 30% increase, it is a small proportion of hedge fund assets globally given that Japan is a major financial market. Total hedge fund assets are estimated to be near $2 trillion, and last year’s growth globally is estimated at $500 billion.
There are several issues at play, say funds of hedge funds, although the poor performance of funds in 2006 is crucial. "Japanese managers have had greater difficulty raising capital recently than, say, two years ago," says Tom Sandlow, senior vice-president and global director of manager research at Tremont Capital Management. "There is a higher concentration of long/short equity players in Japan, and that strategy as a whole performed poorly last year. In 2005, Japanese long/short players produced high returns because of bets on small caps, which were significantly undervalued. In 2006, however, that opportunity had gone and small caps were trading at equal value or a premium to large caps. Some managers were late adjusting and performed poorly." According to Eurekahedge, Japanese long/short equity funds lost 4.6% in 2006. Event-driven funds in Japan lost 7.18% and multi-strategy funds lost 5.02%.
Harold Yoon, portfolio manager and head of the fund of hedge funds business at ING, says: "Some funds of hedge funds were disappointed with returns. Their expectations are not optimistic either and funds have seen investors de-allocating."
Domestic Japanese financial institutions such as trusts and banks have further been discouraged from investing, says Yoon, because of Basle II capital requirements. "One investor in Japan estimates that his firm would need to put aside four times as much capital than prior to Basle II. As a result his firm needed to redeem its entire hedge fund portfolio until it had better worked out how to set the capital aside. Domestic investors are certainly being more conservative about investing while they come to grips with the new requirements."
The Personal Information Act passed in 2005 in Japan could also affect the ability to raise capital from foreign investors. The legislation makes it difficult for investors to access information about managers’ past employment records, and some analysts believe it could deter investments as the new law plays out. "It seems to be like the US 10 years ago when it would have been considered disrespectful to call up a manager and ask for their background, or call former employees and ask them to verify a person’s credibility. These days in the US I don’t think that is unusual at all, and foreign investors consider that to be an integral part of the due diligence process. I think it will be interesting to see how foreign investors cope with this Act, and whether it might have to be rethought," says Randy Shain, vice-president of First Advantage Investigative Services, producer of the BackTrack Report. Yoon says that so far he has not seen evidence of Japanese managers refusing to disclose information because of the Act.
Sandlow says it will be interesting to see how the Japanese hedge fund market evolves. As an increasing number of investors try to seek out strategies that are not long/short in order to diversify their portfolios, Japan could well end up being left behind. He says: "Ten years ago, Japan was the place for convertible arbitrage and warrant arbitrage. But with the economy having done badly, the significant cross-holdings still in place, lack of shareholder rights, and no high-yield market, the opportunity set for hedge funds in Japan is extremely limited. The long/short strategy can only offer so much."