Investors suffer as Asian hedge funds ossify

As institutions take over from high-net-worth individuals and family offices as the main investors in hedge funds around the world, those hedge fund managers, too, are becoming institutionalised. This is not always a good thing for investors.

By ‘institutionalised’ we mean providing greater stability in ownership and management structures, better governance, compliance, liquidity and transparency. In any funds management business, that requires a certain level of assets under management. And in any funds management business, especially hedge funds, more assets under management often times means reduced returns to the investor.

However, not all markets are the same. In Asia, for instance, the volatility of those markets provides extra opportunities for hedge fund managers. And their adoption of institutionalised practices, as mentioned above, may be a small price to pay to take advantage of those opportunities.

According to Andrew Gordon, the Asian head of alternative investment services for the big custodian and funds management company BNY Mellon, the new money flows into Asian hedge funds and private equity programs which became evident in 2010 are likely to accelerate in 2011.

But the new globally sourced money is more demanding. Gordon says these investors are looking to gain increased insight into the managers, looking beyond historical performance numbers to get to the bottom of how sustainable the team, business structure and strategies are.

The fact that each of the big global asset servicing firms – such as BNY Mellon, State Street, JP Morgan and BNP Paribas – are reporting strong business growth in Asia Pacific emphasises the ‘institutionalising’ theme.

Each of those custodian banks has minimum accounting, reporting and compliance standards to which clients must adhere, for systems reasons if nothing else. The stereotypical hedge fund operated out of some clever person’s bedroom, whether or not that was ever true, is a thing of the past. And the minimum standards of the custodian banks usually come, of course, with a minimum fee.

A former chief executive of BNP Paribas’ asset servicing division, the Belgian Jacques Philippe Marson, once famously predicted that he could see the head office of at least his division of the bank moving from Paris to Beijing in his lifetime. Sacré bleu.

BNY Mellon’s Gordon says the institutionalisation trend of the hedge fund industry is rapidly moving from the US and Europe into Asia.

“This is what we believe will eventually and effectively differentiate winners from losers in the marketplace, specifically for those smaller hedge funds from the region,” he says.

“Post-financial crisis, global hedge funds are also reviewing their presences in Asia. With a number opening offices in Hong Kong and Singapore, competition intensifies more rapidly than ever.”

Apart from greater volatility to work with – which hedge fund managers thrive on – Asian hedge funds also offer better beta. According to the latest figures from UK research firm EDHEC Risk, emerging markets funds have averaged the highest annual return of all hedge fund strategies since January 2001 – 12.5 per cent.