Japan's Hedge Heyday

Funds are sprouting and thriving, despite the red tape

On a steamy summer evening in Tokyo, more than 200 young Japanese and Westerners dressed in dark pinstripe suits gather to swap business cards and clink free mugs of beer courtesy of a leading European brokerage house. The occasion? An invitation-only hedge fund networking event on the terrace of a French bistro drawing some of the top talent in Japan. Five years ago only a handful of hedge fund managers operated out of Tokyo. But today the alternative investment community is mushrooming as billions of dollars, euros, and yen seek exposure to Japanese markets with a hedge fund twist. "The environment is finally ripening for hedge funds," says Masaru Kontani, managing director at Tokyo-based Hachibushu Capital Ltd.

Indeed, hedge funds, which invest for institutions and wealthy individuals by making bets on stock and bond market movements, are hot all over Asia. Assets under management in Asia-focused funds have been growing at a rate of 35% a year since 2000, according to researcher Eurekahedge, and some 607 Asian hedge funds now manage $70 billion. Japan, with its deep capital markets, accounts for about 30% of that money.

And Japan-focused funds are on a hot streak. Eurekahedge's Japan Hedge Fund Index is up 7.83% for the year, compared with 3.93% for North American hedge funds and 1.19% for the Standard & Poor's 500-stock index. One big Japanese-run fund, Tower Investment Management Co., did so well last year that a senior trader's bonus made him Japan's top taxpayer, with an estimated income of nearly $100 million.

Pensions in a Pinch

Traditionally, Japan's insurance companies and pension plans have parked their assets in low-risk corporate and government bonds. But yields have been at record lows, and there is concern that bond prices will crash if, as the economy improves, interest rates rise. Moreover, given Japan's aging population, pension funds must earn more on investments or raise contribution rates. "It's one of the great unanswered questions of the global economy: How can Japanese assets be more efficiently allocated?" says Mark Mason, a Japanese finance expert at Columbia University in New York.

To narrow the gap, Japanese institutions, like their counterparts in the West, are diversifying into hedge funds or hedge-like investments. A Nikko Asset Management survey last November found more than half of the responding Japanese corporate pension funds had begun to invest in hedge funds just in the previous 12 months. "We're seeing more Japanese corporate pension fund money all the time," says Makoto Kikuchi, CEO of Myojo Asset Management, which manages $570 million. The amount institutions invest is rarely more than 3% of their assets. And they usually invest in funds-of-funds to limit risk. "We use funds-of-funds as gatekeepers," says Nobuki Yasuda, general manager of alternative investments at Sumitomo Life Insurance Co., which invests about 2% of its $200 billion in assets in hedge funds. "It's hard to find jewels among the rocks."

The pot of gold at the end of the rainbow for hedge funds is Japan's ultraconservative public pension system, which oversees $1.3 trillion in assets. For now, that money is off limits to the alternative investment community. But that may change starting in April, when the government sets up a new management organization. "The financial condition of the public pension system is deteriorating, so we need to consider a more diverse range of investments such as hedge funds," says Noboru Terada, executive investment officer of the Japan Government Pension Investment Fund.

Yet for Tokyo-based hedge funds to truly thrive, Japan will have to do more than just tolerate their existence. Right now, an opaque licensing process and heavy tax liabilities mean that most Japan-focused funds must execute trades through offices in Hong Kong, Singapore, or even Honolulu. Japanese financial authorities seem unsure whether to embrace the fledgling industry or chase it away. "From a regulatory point of view, Japan has been behind the curve," says Jason Bajaj, who runs Hachibushu Capital, which manages some $300 million.

Of course, the big concern of officials in Japan is the same as that of officials everywhere -- that hedge funds are secretive, unregulated, often volatile investment vehicles that have been known to abruptly collapse, taking investors' money with them and destabilizing the financial system. But until the next big meltdown, Japan's nascent industry will continue to bloom.

By Chester Dawson in Tokyo

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