September 23, 2008 / 8:39 AM / 11 years ago

Crisis to spur big Asia hedge fund shake-out

HONG KONG/SINGAPORE (Reuters) - Asia’s hedge fund industry, one of the world’s worst performers even before the latest surge in volatility, will see a major shake-out as the global financial turmoil shuts down a huge swath of managers.

Few in the industry will guess at how many of an estimated 1,200 Asia-Pacific-focused hedge funds will fold in the months ahead. But higher losses and rising redemptions suggest things will be proportionately worse than for U.S. and European funds, they warned.

“This is a watershed for the industry ... a lot of players are not going to be here by early next year. Those with high leverage and many smaller players will be gone,” said Low Jeng-tek, the Asia head of UK-based fund of hedge funds manager Gems Advisors, which oversees more than $7 billion.

While the worst global financial crisis since the Great Depression was caused mainly by problems with the U.S. housing markets and investment banks, Asian hedge funds have actually done much worse than their U.S. and European peers.

After five straight years of double-digit percentage gains, the Eurekahedge Asian Hedge Fund Index is down 12.6 percent this year and its Japanese index is off 7.7 percent. This compares with a 0.25 percent loss for its North American index.

Hedge funds are supposed to deliver gains in both rising and falling markets, using strategies and tools such as leverage and short selling not available to traditional investments. This is why, unlike mutual funds, they typically charge performance fees of 20 percent on top of management fees of 1-2 percent.

MORE WHIMPER THAN BANG

Analysts said part of the reason for Asia’s poor performance is that a larger proportion of managers use an equity-focused long/short strategy in which they mostly buy stocks they hope will rise, with a small proportion of short bets, which profit when stock prices fall.

Eurekahedge estimates that about 46 percent of the $168 billion in Asia-focused hedge fund assets in August were managed using a long/short equity strategy, compared with 34 percent for U.S. funds.

U.S. managers are more likely to use complex and sometimes highly levered strategies like convertible bond arbitrage and trading volatility using options.

Short selling has traditionally been more difficult in Asia, partly because less liquid markets make it more expensive and risky.

The practice has been in the headlines globally with authorities in several markets cracking down on short sellers. But many Asian countries already had restrictions in place for years. China bans it outright and Hong Kong’s shorting rules date back to the 1997-98 financial crisis.

Critics say as a result, Asia-focused funds are often long-biased, collecting hefty fees in rising markets but offering little downside protection.

“You have a number of managers with extremely poor performance in the long/short side in China and India,” said Ferenc Sanderson, senior research analyst with fund tracker Lipper, a unit of Thomson Reuters.

Sanderson said up to half of managers could see significant withdrawals from their funds, particularly at the start of the fourth quarter and at the year-end as investors cut their losses.

“This is going to be a brutal period,” he said.

Unlike the high profile failure of Australia’s Basis Capital last year, these closures will likely be more whimper than bang, with managers quietly returning investors their much diminished savings and slipping out of existence.

There should be “no blow-ups, as Asian managers generally don’t use much leverage,” said Peter Douglas, founder of hedge fund consultancy GFIA.

Funds which have already been shuttered include the Melchior Japan Fund run by Dalton Strategic Partnership, which has kept open its Melchior Japan Fund 002 vehicle.

Given that many funds have lock up periods of 30 days or more, redemptions are expected to pick up after the end of the third quarter on September 30 and gain pace next year.

HELL OR HIGH WATER

While rising redemptions are putting increased pressure on Asia-focused hedge funds, another major problem is that most funds can only charge small management fees until they surpass their previous highs.

With MSCI’s measure of Asian stocks outside Japan .MIAPJ0000PUS down about one-third this year, the fat performance fees managers crave could be years away.

“Some of these funds are as much as 20-30 percent down for the year. So that’s a very significant high water mark that they’re going to have to recover to,” said a Hong Kong-based executive with a fund of hedge funds manager, who was not authorized to speak to the media.

“If you’re at about $100 million or so (in assets) and you’re suffering significant losses, it’s not clear to me that you’d want to continue on and it may be easier just to fold.”

The fund industry veteran said by comparison funds with $500 million or more would be in a better position to survive on management fees alone. But Eurekahedge estimates just 10 percent of Asia-Pacific hedge funds manage $500 million or more.

However, GFIA’s Douglas said the downturn could be healthy in the long run.

“The Asian hedge fund industry has been too hot for a couple of years, and we need to lose some of the more entrepreneurial players that have come in at the margin.”

Additional reporting by Kevin Lim in SINGAPORE; Editing by Lincoln Feast

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