When you look at the alpha per unit of risk that you can capture in a good Asian hedge fund manager, it’s far better than what you’ll see anywhere else
In some of our portfolios, around 40% of our equity allocation is directed toward Asia.
Hedge fund investing - the current opportunity set in Asia
“Hedge funds are a relatively new part of the investment landscape in APAC,” says Benno Klingenberg-Timm, Head, Global Sovereign Markets, APAC at UBS Asset Management. “They haven’t been around for as long as they have been in the U.S. or Europe, so there’s not the same history – but you do have very strong performance, and we think the growth of the market will continue to be there, which underlines a continued opportunity set. This is not a short-term perspective. This is really a 10- to 20-year opportunity in Asian hedge fund investing. There will be ups and downs, but there will be a secular shift to this part of the world, and continued growth from Asian investors.”
It’s not hard to argue that Asian equity markets provide an attractive environment for alpha generation. The China A-share market is the second largest equity market in the world and one of the most liquid. Yet it remains hugely inefficient. Approximately 70% of the A-share stocks are covered by fewer than three analysts. This contrasts with the US and Europe where roughly 15% of stocks have such limited analytical coverage (see fig. 1). It is no coincidence that single stock dispersion, a measure of the opportunity for active managers to add value, is nearly double in the Chinese equity market than it is in Europe and the U.S. (see fig. 2).
Figure 1: Coverage of companies with USD 500m market cap
Figure 2: High dispersion of returns in China
Unlike other markets that have seen the level of crowding increase, Asian equity markets currently possess low levels of overall institutional and hedge fund capital that makes the aforementioned inefficiencies more pronounced. In China, the A-share market ownership is dominated by domestic retail investors, with foreign ownership at only 7.3%.1 The dominance of retail investors in Chinese equities and their high portfolio turnover provides plenty of opportunities and liquidity to exploit dislocation. Average annual turnover over the past five years expressed as a percentage of total market capitalization has been significantly higher in the Chinese equity market (266%) than in other developed markets such as the U.S. (126%).2
This is not a short-term perspective. This is really a 10-to 20-year opportunity in Asian hedge fund investing.
Opportunity beyond China
Outside of China, there are potential opportunities arising from corporate governance improvements in Japan and Korea, plus a continuation of high levels of idiosyncratic event activity. Since the introduction of stewardship/corporate governance codes and the new M&A guidelines in Japan, the last two years have seen record numbers of subsidiary sales or transfers and share buybacks.3
The increased amount of private equity capital and activist campaigns in Japan has also resulted in more corporate activity, with a renewed focus on shareholder rights as well as providing a catalyst for value creation.
“We favor Asia, and our allocation mainly consists of equity hedged managers that have shown outsized alpha generation and the ability to manage risk during high levels of volatility,” says Adolfo Oliete, Head of Asia-Pacific Investments, UBS HFS. “In addition, we look for managers who have the ability to perform in volatile or dislocating markets by providing liquidity to the market – for example, multi-strategy managers."
In the near future, pending Qualified Foreign Institutional Investor (QFII) regulation changes, we expect to be able to allocate to some onshore China strategies that have not previously been accessible to offshore capital.
“As we look ahead, the evaluation of risk relative to reward remains paramount,” continues Oliete. “With risk premia compressed across most asset classes, we are focused on identifying idiosyncratic opportunities. Most importantly, we focus on active management in the region. In an Asian hedge fund universe demonstrating high return dispersion, manager selection and exit decisions are paramount to the delivery of investment outcomes.”
In very recent years, we've seen new Asian hedge funds raise as much as $3 billion - that would not have been possible five years ago if you hadn't marketed yourself in the U.S. and Europe. Today, there is … a willingness to put money with them (Asian hedge fund managers).
Hedge fund investing - taking advantage of the opportunities
The effects of the COVID-19 pandemic have challenged economies around the world, but when 2020 is wrapped up, China will likely prove to be the only large country that has contributed to global GDP growth. It’s no surprise to institutional investors who are enticed by such growth that access to China can be a challenge – especially in the hedge fund space – but it can be decidedly less so when working with an investment partner that knows the lay of the land.
One of the first foreign asset managers to enter China was UBS Asset Management (through a local joint venture), and in the nearly 15 years since doing so it has made China – and Asia overall – a top strategic initiative. As such, investors who work with UBS HFS in a fund of funds context find that the necessary resources have long been in place, and the relationships and knowledge run deep.
We have allocated around $28 billion to Asian hedge funds over the years, so this is not new to us,” says Oliete. “The length of time we’ve been in the region has allowed us to scale our team and solutions to a size appropriate for such a large universe. We have more than 15 people who are dedicated to hedge funds in Asia.
What really stands out for UBS-AM in the Asian hedge fund space is its onshore presence in China. To launch products in China requires a license, and it is the first foreign player to launch an onshore fund of private funds – funds that are registered in China and offered to Mainland investors.
“The license allows us to have people on the ground, which we do in Shanghai, but also gives us the opportunity to expand the universe of coverage on investments that were previously unavailable to offshore investors due to QFII regulations,” says Oliete. “That is changing, and regulations have expanded what offshore investors can invest in, including Chinese hedge funds that are based in China and registered in China. In that context, we don’t have to catch up on our knowledge of these firms – we’ve been looking at them and getting to know them all along.
People, presence, and approach
Amlicke, says his group’s work with Asian hedge funds is focused on three things: people, presence, and approach.
“Over the past five years, we’ve ramped up our level of activity and built out our resources even further in the region,” says Amlicke. “Part of what drove it was the U.S equity hedge landscape five years ago. You could really see the increased crowding and a lot of smart cap investors going after the same alpha. It was frustrating, because you’d see periodic factor rotations and de-leveraging events, which would drive correlated losses. Part of really moving more aggressively to Asia was moving away from that and moving toward less crowded opportunities.”
Amlicke and Oliete look to build their team with people who have been direct risk-takers at some point in their career.
Whether they’ve been working for a hedge fund or a prop desk, infusing their experience as direct risk-takers into our decision-making process really fuels our experience in evaluating hedge funds and providing seed funding for a lot of great ones early on,” says Amlicke. “Our deep roots in the region have enabled us to be able to spot talent early and be comfortable with that exposure.
The approach part of the equation offers investors tremendous flexibility to shape the relationship with UBS HFS. Whether it’s advisory, discretionary or semi- discretionary mandates, APAC-only, emerging managers, or co-investments only, to name a few examples, the pieces can be put together in the way that best suits the asset owners.
Such flexibility creates a comfort level for investors in what Amlicke describes as the perfect hedge fund market.
“Asia overall has far less hedge fund capital than other markets, and on top of that you have the top-down aspects of powerful secular thematics in China’s efforts to rebalance its big, growing economy and move towards the digital consumer. Along with this secular growth, there’s cyclical growth and huge volatility, so it’s really an opportunity to take advantage of long and short positions.”
Vetting for transparency in Asian hedge funds
Investors are attracted by the alpha potential hedge funds represent, but not as keen on what historically has been a lack of transparency. With Asian hedge funds newer to the scene than their peers in North America and Europe, it’s natural for investors to be curious about how UBS Hedge Fund Solutions selects the funds it invests in – and how those funds are themselves managed.
UBS Hedge Fund Solutions
UBS Hedge Fund Solutions (HFS) offers a wide range of hedge fund solutions including commingled products and customized discretionary products, as well as portfolio advisory and strategic advisory services. The firm is headquartered in Stamford, Conn., with additional offices in New York, London, Zurich, Hong Kong, San Francisco, Shanghai, Tokyo, and Krakow.
As of 1 October 2020, HFS currently manages approximately USD 35.9 billion and has allocated over USD 275.5 billion since inception. UBS Hedge Fund Solutions (HFS) was founded in 1994 and is a wholly owned subsidiary of UBS Asset Management (Americas) Inc.
HFS is the second largest hedge fund manager globally (Source: HFM InvestHedge Billion Dollar Club, published March 2020).
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