Hedge-Fund Mania Hits Asia

Individuals and even governments have started piling into the risky vehicles

Hedge Funds are by reputation a risky and esoteric investment category that ordinary investors had best avoid. But don't repeat that mantra in Asia. From Tokyo to Singapore, hedge funds are as hot as Thai chili peppers. "It's crazy," says Jim Rogers, the legendary co-founder (along with George Soros) of the Quantum Fund. "Everybody is setting up a hedge fund. I am told a new hedge fund is being set up in Asia every other day."

That may be an exaggeration. But funds that bet on interest-rate and currency movements, make long and short wagers on stock and oil prices, and seek to exploit bond market inefficiencies are certainly all the rage. In 1999 there were 162 Asian hedge funds managing $13.8 billion; today there are more than 500 funds managing in excess of $59 billion, according to Eurekahedge, a Singapore-based consultant focusing on alternative investments. More than 100 new funds were started in the first 11 months of 2004 alone, most of them in Japan, Hong Kong, and Singapore.

Everyone from Asian retail mutual funds to private banks representing wealthy individuals to government pension funds are joining in. "It's just been going gangbusters," says Alexander Mearns, chief operating officer and director of Eurekahedge. "In the last 3 1/2 years we have seen Asian hedge funds grow beyond anyone's wildest imaginations."

How mainstream are such investments becoming? The Singapore government investment firm, Temasek Holding, launched its $300 million Fullerton Short Term Interest Rate Fund in November. The move is part of a plan by the state company to build a fund management arm that will be open to both public- and private-sector investment. Among the subscribers to the Fullerton fund are cash-rich government-linked companies within the Temasek fold, and Temasek itself, which generates $1.4 billion a year in dividends from its listed portfolio.

The rapid growth in hedge funds is especially remarkable given Asia's recent history. It was just a few years ago that government officials across the region were bitterly blaming speculators for the Asian financial crisis. But since then, the perception that hedge funds are inherently risky has dissipated. "I think investors are only just starting to understand that there are different types of hedge funds, and a lot of them aren't half as risky as they are perceived," says David Zobel, a managing director of Deutsche Asset Management in London. In addition, Asian investors who are frustrated by low interest rates and bond yields, and by volatile stock markets, have been turning to hedge funds to give their portfolios a pop. "There is so much capital around the world these days looking for a home and, increasingly, investment managers are looking for better returns," says Sharon E. Hartline, head of the Alternative Investment Practice Group at international law firm White & Case LLP in Hong Kong.

THE BANDWAGON EFFECT

The odd thing is, hedge funds in the past year have been a bad bet. Average returns on such investments plunged from close to 30% in 2003 to a paltry 5% in 2004, according to Dutch bank ABN Amro (ABN ). "In a very strong market environment like we've had this year in much of Asia," says Zobel, "hedge funds tend to underperform, just as they outperform in a very difficult environment."

Yet the disappointing returns haven't stopped the funds' growth. Hedge-fund assets globally broke through the $1 trillion mark in July, 2004, with funds invested in Asia approaching 6% of that total. Tom Ashworth, a director at KE Absolute, a hedge-fund services company in Hong Kong, expects the Asian share to grow to more than 10% of the total by 2007, or about $200 billion -- partly as a reflection of the region's growing wealth. Eurekahedge's Mearns predicts the proportion will rise even more. "Asian equity markets make up just under 16% of total market capitalization of all of the world's listed companies, so it's not a big stretch to assume hedge-fund assets in Asia could grow to a similar size in five or six years," he says.

Some of the most enthusiastic hedge-fund investors are wealthy individuals who used to sink most of their money into real estate -- a bad investment over the past decade in locales such as Tokyo and Hong Kong. High-net-worth private Asian investors, says Michael Benz, a managing director for wealth management at Swiss bank UBS (UBS ) in Hong Kong, have caught on to hedge funds far quicker than their European counterparts because they are "more market-savvy and often more hands-on in their investment decisions. There is a growing realization among wealthy Asian clients that hedge funds provide better diversification."

In the past, experts say, 70% of the relatively small pot of Asian money in hedge funds was invested in long-short equity strategy funds. That means money managers took long positions in some stocks and sold other stocks short to hedge against the ups and downs of the markets. Good stockpickers made fancy profits. Today just half of hedge-fund money is in long-short funds, with the rest in riskier areas. Those include commodity pools, which bet on swings in commodity prices; arbitrage funds, which seek to exploit inefficiencies in the bond markets; and macro hedge funds, which try to predict macroeconomic events such as movements in interest rates and currencies. "The trend is away from plain vanilla long-short to more sophisticated arbitrage and quantitative funds that exploit all sorts of market inefficiencies," says Mearns. Fees for hedge funds in Asia are typical of those in the industry: a 1% to 2% management charge, plus 20% of any profits.

What about the risks? One is the bandwagon effect. Rogers has been traveling around Asia warning investors that there are too many hedge funds with similar strategies that are chasing too few assets.

PROTECTIONS

Yet Asia has some protections from hedge-fund excess, especially in countries where such "alternative" investment is restricted by local laws. In Korea, Malaysia, and Thailand, retail investors are forbidden from investing in hedge funds. Short-selling of stocks is also restricted in many Asian markets, which typically have lots of illiquid small stocks that can easily be manipulated. And in some of Asia's more open markets such as Hong Kong, says White & Case's Hartline, short-selling is permitted only in midsize and large- cap stocks.

Even hedge-fund sellers concede the risks of shifting large quantities of Asian assets into hedge funds. "Hedge funds are not suitable or desirable for all investors," says UBS' Benz. If a cautionary tale were needed, it came in late November in Singapore, when locally listed China Aviation Oil Singapore Corp. declared bankruptcy. Traders for CAO, whose home base is Beijing, in effect turned the company into a hedge fund by spending its spare cash buying derivatives that bet on a fall in the price of oil. When the price rose, CAO raised its bet, eventually losing a reported $550 million. No Asian hedge fund has experienced such a debacle. But this is definitely a game for grownups.

By Assif Shameen in Singapore

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