AIJ’s Madoff-Like Returns Post-Lehman Shock Raised Red Flags for Investors

Tetsuo Ochi, searching for asset managers for his $6 billion fund of hedge funds, sought a meeting in early 2009 with executives from AIJ Investment Advisors Co., a firm that seemed to be faring well amid the market turmoil that followed the collapse of Lehman Brothers Holdings Inc.

“We requested to do due diligence through an investor who had put money with AIJ,” said Ochi, chief executive officer of MCP Asset Management Co. in Hong Kong, noting that Bernard Madoff, who had refused to meet with clients, had admitted a few months earlier to running a multibillion-dollar Ponzi scheme. “But we were turned down as they told the investor they don’t need clients who want to do due diligence on them. That was enough for a fund not to invest in them.”

Like Madoff in New York, Tokyo-based AIJ told prospective investors it could provide stable gains regardless of market moves, and it targeted Japanese pensions looking for higher returns to fund their increasing retirement benefits. The firm was suspended on Feb. 24 by Japan’s financial regulator after it couldn’t account for all of the 185.3 billion yen ($2.3 billion) it managed for clients as of March 2011, sparking the biggest investigation in the history of the nation’s fund industry.

Not Accused

Neither AIJ, nor its top executive, former Nomura Holdings Inc. (8604) manager Kazuhiko Asakawa has been accused of wrongdoing following the firm’s suspension by the Financial Services Agency. Phone calls to AIJ’s main office were answered by an automatic recording which didn’t allow messages to be recorded.

AIJ made money even as stocks slumped following the March 11 earthquake in Japan, said Makoto Kikuchi, chief executive officer at Myojo Asset Management Japan Co., a Tokyo-based hedge fund advisory firm. He also noted that the increase in assets at AIJ’s funds after the collapse of Lehman Brothers in September 2008 was unusual. In 2008, hedge funds had their worst annual performance, with returns falling an average of more than 18 percent and industry assets declining 40 percent to $1.1 trillion.

“When we met with AIJ a few years ago, there was already circumstantial evidence that they were suspect,” said Taro Ogai, the head of investment consulting at Towers Watson & Co. in Tokyo. “We have been warning our clients for more than year how we were concerned about AIJ.”

Red Flags

Towers Watson, which advises pensions on investments, did calculations using AIJ’s returns and assets under management that indicated the funds’ positions were too big for the derivative markets that the firm claimed it was trading in, Ogai said. The firm declined to say whether it contacted regulators.

“If that’s the case, AIJ should have been much more popular in the market,” he said.

Ogai said he was concerned that AIJ’s returns were very high, while disclosing little about its strategy. That one of AIJ’s executives, Shimpei Matsuki, had been arrested was also a red flag.

Matsuki, chief investment officer at AIJ, was one of three ex-Nomura executives to receive suspended sentences in 1999 for paying off a corporate extortionist who threatened to disrupt the brokerage’s 1995 shareholder meeting.

Suspension, Probe

The FSA ordered AIJ to stop business for a month as the regulator investigates how it managed money. AIJ had 122 contracts with domestic corporate pensions and one with a foreign investor as of March 2011, according to filings with Japan Securities Investment Advisers Association.

Any action against AIJ depends on the outcome of findings by the Securities and Exchange Surveillance Commission, the financial watchdog under the FSA, Financial Services Minister Shozaburo Jimi said yesterday.

Japan today began its biggest investigation of asset management firms following the suspension of AIJ, in a move that may lead to tighter oversight of pension money investment. A total of 265 asset managers nationwide will be required to submit status reports to the financial watchdog by March 14, the FSA said in a statement in Tokyo today. The reports must contain details of a firm’s operations, contracts and their amounts, and any past complaints from customers.

The ruling party will form a working team under its financial committee as soon as tomorrow to discuss changes to rules governing investment managers for pension money, Tsutomu Okubo, a lawmaker who leads the panel, said in an interview in Tokyo today. Okubo, 50, expects a bill to amend the Financial Instruments and Exchange Law will win Cabinet approval as early as mid-March and then be sent to the Diet.

‘Natural to Suspect’

“Towers Watson cannot agree to a possible move by FSA to tighten rules and oversight on asset management firms because of this,” the firm said in an e-mailed statement today. “If you had an understanding of what it means to invest, it was natural for anyone to be suspicious” about AIJ.

Assets under management at AIJ stood at 126.2 billion yen with 89 clients as of March 2008, before the collapse of Lehman Brothers, according to the securities association. Following the credit crisis, the number of clients grew to 125 with 177 billion yen as of March 2009.

Myojo’s Kikuchi heard about AIJ six months ago as a fund with “unusually good performances.”

“It was weird that this fund that was making money by selling options would not have any losses after the Great Eastern earthquake,” Kikuchi said. “Usually, funds that trade options would get hit with the kind of volatility we saw back after the temblor.”

Nikkei 225 Options

The Nikkei Stock Average Volatility Index (VNKY), a gauge of Japanese option prices, almost tripled in the two business days following the March earthquake and tsunami that led to the worst nuclear crisis since Chernobyl in 1986, while the Nikkei 225 fell the most since 1987.

Alternative investment managers that eschew traditional investments such as stocks, bonds and cash have come under scrutiny in the past four years, since the collapse of hedge funds run by Bear Stearns Cos. in 2007. Madoff was arrested in 2008 for operating the largest Ponzi scheme in U.S. history and hedge fund Galleon Group LLC co-founder Raj Rajaratnam was found guilty in May on insider-trading charges.

AIJ’s AIM Millennium fund returned 241 percent since it started in May 2002 by mainly trading Nikkei 225 options, according to a four-page October 2011 newsletter in Japanese obtained by Bloomberg News. The return compared with a 22 percent drop by the benchmark Topix Index (TPX), according to the newsletter.

Asakawa’s Pitch

The Millennium fund mainly invested in Nikkei 225, using an index that AIJ created to gauge whether markets were overbought or underbought, according to presentation materials provided to a pension fund that were obtained by Bloomberg News. The undated document didn’t name the pension fund.

About two years ago, Asakawa came to visit a Japanese pension plan to sell AIJ’s funds that invested in Nikkei 225 options that showed positive returns even after Lehman Brothers, said the pension’s fund manager, who asked not to be identified because the meeting was confidential. The Nikkei 225 Stock Average (NKY) tumbled more than 40 percent after Lehman Brothers collapsed in September 2008 to a low in March 2009.

In the middle of the meeting, Asakawa would excuse himself to give buy and sell orders for the fund, according to the manager, who said he became suspicious because it’s not a common practice for a top executive to trade his fund away from his office. The retirement plan didn’t invest in the fund even after several visits by Asakawa, the manager said.

Some ended up investing. Koshinetsu Printers Association Pension Fund said it invested with AIJ because it was run by a former Nomura manager and offered 7 percent returns. Among other corporate pension plans that put money with AIJ are Advantest Corp., a maker of memory-chip testers, Yaskawa Electric Corp., Fuji Electric Co. and a truck driver pension plan.

“If you had done the basic due diligence, this problem could have been avoided,” MCP’s Ochi said. “It must have been the mid-to-small sized pensions that they sold -- it’s a very sad development.”

To contact the reporters on this story: Tomoko Yamazaki in Singapore at tyamazaki@bloomberg.net; Komaki Ito in Tokyo at kito@bloomberg.net

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net

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