Barclays study highlights capital raising opportunities in APAC

Prime Brokerage
28 May, 2014

There could be up to $70 billion in assets up for grabs for hedge funds marketing into Asia-Pacific (APAC), according to a study by Barclays Prime Services Capital Solutions.

Despite its size, the Asian investor market has been slow to embrace hedge funds, accounting for just 6% or $150 billion of the $2.7 trillion currently controlled by managers globally. Of this $150 billion, $70 billion originates from Japan, the majority of which is derived from trust banks, distributors and consultants.

The Barclays study estimates there will be approximately $10 billion to $15 billion of hedge fund inflows from Japan over the next three years. It expects corporate pension plans will grow their hedge fund exposure from 8% to up to 15% over this time-frame with estimated flows of between $15 billion and $20 billion.

The key drivers for this increase, said the study, will be Abenomics and pension reforms. Following the recently enacted fiscal stimulus, monetary easing and structural reforms, a growing number of corporate pension funds are reallocating from bonds to risk assets to take into account the growing challenges of inflation and increasing yield. Many corporate pensions are seeking to “lock in” gains achieved in the recent equity market rally by reducing their exposure to equities and ramping up allocations to absolute return vehicles.  

However, the Barclays study estimates industry pension funds in Japan will reduce their exposure to hedge funds by up to $10 billion following government reforms that are likely to see assets migrated onto the Government Pension Investment Fund. It added that Japanese banks will also be forced to reduce their exposure to hedge funds as Basel III will require these financial institutions to disclose their fund investments on a look-through basis. The added costs of data compilation and reporting is going to make hedge fund investing a far more expensive proposition for these banks, and is likely to facilitate redemptions of between $5 billion and $10 billion.

Australia is another attractive APAC market. Australia-based investors allocate roughly $40 billion to hedge funds, with superannuation funds accounting for 50% of that. The $1.5 trillion superannuation fund market in Australia cannot be ignored, and is growing rapidly, and is forecast to reach $1.9 trillion by 2016. The Barclays study said superannuation funds are projected to invest an additional $4 billion into hedge funds over the next three years. 

Nonetheless, hedge funds soliciting capital from superannuation funds in the country must be fully compliant with the MySuper rules laid out by the Australian Prudential Regulation Authority (APRA). The rules are designed to curtail hedge fund fees amid regulatory concern that high-cost products were being marketed to superannuation funds. Under the proposals, hedge funds could be forced to reduce their management fee if they charge a performance fee.

The rules will also measure investment managers’ performances against a benchmark to ensure they do not charge incentive fees when returns are poor. Most experts predict hedge funds, given the dearth of available capital and the sheer size of the Australian superannuation fund market, will accept these conditions. MySuper will also force trustees at superannuation funds to disclose portfolio holdings at an asset level to their shareholders on a bi-annual basis. In April 2013, it was also revealed APRA was considering requiring hedge funds to adopt the Open Protocol Enabling Risk Aggregation (OPERA) initiative, the risk reporting tool developed by Albourne Partners, if they manage money on behalf of superannuation funds.

"MySuper reforms will likely put more pressure on hedge fund managers to reduce fees and provide greater portfolio transparency, and therefore might be a hindrance to those managers who are unwilling to comply with these requirements. However, given the superannuation fund industry's fast AuM growth, we expect overall hedge fund allocations from superannuation funds to increase in the next three years. A number of the managers we interviewed have made or are making changes to their existing fund terms and disclosure practices, or developing new products to take advantage of these opportunities (in Australia)," said Anurag Bhardwaj, director of hedge fund consulting at Barclays Prime Services in New York. 

The Barclays study highlighted South Korea, despite its impressive investor pool and huge sovereign wealth fund (SWF) market, was reluctant to allocate to hedge funds. It added approximately $4 billion was managed by hedge funds on behalf of South Korean investors. Nonetheless, these institutions are not averse to alternative investing more broadly. Barclays highlighted the average institution had 10% of its portfolio invested in alternatives with a heavy bias towards private equity and real estate. Many of these investors are loath to deviate from private equity and real estate, which have yielded decent returns of late. Others simply view hedge funds as speculative and high-risk.

Nonetheless, some US-based managers are taking a growing interest in South Korea. SkyBridge Capital, the $10.3 billion New York-based fund of hedge funds, entered a strategic partnership with Woori Investment and Securities, one of South Korea’s largest securities firms in 2013, in an attempt to boost the profile of hedge funds in the region. The deal enabled SkyBridge to distribute its products into the South Korean market although little has been heard since.

Bhardwaj is less optimistic about South Korea. "In terms of hedge fund investing, we do not think of Korea as where Japan was 15 or 20 years ago. Japan's near zero interest rates and slumping stocks in the late 1990s and early 2000s made hedge funds' absolute return proposition a compelling one. In comparison, Korea's relatively high cash rate at 3.7% and strong equity run significantly raises the opportunity cost to investing in hedge funds," said Bhardwaj. 

China is another market which managers ought to consider, although it remains in its infancy in terms of hedge fund investing.  The country’s SWFs appear to be the only active hedge fund investors as other allocators are generally cut off or prohibited from investing in the asset class. Hedge funds are not included in the list of Qualified Domestic Institutional Investor (QDII) investments for insurance companies although the study said it expected the rules to be eased as China liberalises its capital markets. Shanghai, through its Qualified Domestic Limited Partner (QDLP) programme is permitting a limited number of foreign hedge funds to tap its wealthy private investor community for capital.

However, there are major restrictions.  Only six hedge funds – Canyon Partners, Citadel, Man Group, Oaktree, Winton Capital and Och-Ziff – have secured approval from the Shanghai regulator to raise capital on the mainland. Furthermore, the regulator has limited these hedge funds to an overall quota of $300 million to manage, which will be split six ways.  The first movers are likely to reap the advantages should Shanghai and Beijing permit a hedge fund industry to fully develop on the mainland. Nonetheless, Beijing could also turn around and scrap the programme arbitrarily. "It (QDLP) is still in the early stage of implementation, although Citadel, one of the six QDLP approved firms, has recently become the first hedge fund to raise assets from the programme," said Bhardwaj. 

In terms of strategy preferences, APAC investors are broadly in line with allocators globally. Investors appear willing to grow their exposures to long/short equity and event driven, while scaling back their investments in credit and systematic and commodity trading advisors (CTAs).

Size is also a barrier to entry in APAC. The Barclays study warned managers running less than $1 billion that they would struggle to raise meaningful assets.  “Unless the manager has an institutional product and is willing to travel to the region regularly for one to two years, the likelihood of asset raising is low,” read the study. 

APACJapanChinaAustraliaSouth KoreaBarclaysOPERAAlbourne PartnersSkyBridge CapitalAbenomicsmysuperQDLPQDIIAPRA