Asian hedge funds offer perhaps one of the best opportunities for exploiting the vast potential Asia holds for institutional investors. Rapid structural and secular changes in Asia, particularly in China, could be providing institutional investors with the potential for alpha desperately needed in the current yield starved environment. The rapid growth of China is underpinned by several reinforcing factors like the consumption upgrade cycle, urbanization, and aging – with consumption at the forefront of China’s overall economic growth. An increased demand for social services caused by factors including urbanization, has expanded education needs at the same time as aging communities have ever greater healthcare needs. Income growth has also prompted a shift in consumption trends as retail markets grow and online access increases. Additionally, there has been a big push for innovation and automation.
“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,” says Bruce Amlicke, Chief Investment Officer, UBS Hedge Fund Solutions (UBS HFS). “And when you consider the lower correlation of those managers to a global portfolio, even within the equities, Asian and Chinese long/short managers offer great diversification while providing improved expected returns. In some of our portfolios, around 40% of our equity allocation is directed toward Asia.”
An Investor’s Perspective: Ai Ning Wee, Group Chief Investment Officer, Great Eastern Life
Ai Ning Wee describes herself as “an insurance newbie,” but the same cannot be said for the company where she is Group Chief Investment Officer (CIO). Great Eastern Life is one of the largest and oldest insurers in Singapore and Malaysia. She is perhaps a bit more familiar with the potential of Asian hedge funds than many investors. Prior to joining Great Eastern she was a portfolio manager and CEO at Tudor Capital’s regional headquarters in Singapore – she also spent more than 20 years with GIC, the Singaporean sovereign wealth fund. In this interview with II, she shares her knowledge of Asian hedge funds and why she allocates assets to them.
You used to work at a hedge fund, and now you’re a proponent of having Asian hedge funds in a portfolio. What do you see in them?
Ai Ning Wee: The main driver for me is that Asian markets are still relatively inefficient. In fact, I would say they are absolutely inefficient, and hedge funds are in the business of exploiting inefficiencies. Obviously, the evolution of the Chinese market is a big theme in investing and for asset owners like us, when it comes to who best understands the Chinese markets, we find that superior knowledge and expertise lie with the Asia-based asset managers. I have observed China-born fund managers who were educated and worked in the West now increasingly relocating back home to Asia. These are the people who have been active in setting up hedge funds, and I personally feel that they are potentially the people who will generate me the best returns. That said, the big-name hedge funds in U.S. and in Europe have jumped on the bandwagon, setting up offices onshore in China and hiring the best and the brightest. Of course, I also do not rule out investing in these funds.
What do Asian hedge funds add to your portfolio that it might otherwise lack?
Ai Ning Wee: Our research into the Asian hedge fund space has shown that in the last few years, particularly in the China-oriented equity funds – mostly quantitative funds – they have been able to produce fairly consistent outperformance, compared with other global hedge funds. That’s not to say we haven’t seen some global hedge funds generating exceptional 60% to 100% returns, but if you focus on consistent returns offered by market inefficiencies, Asia – particularly China – is the source of the most opportunity.
You are the CIO for an insurance company. How do regulations factor into investing with hedge funds?
Ai Ning Wee: I’ll say first that investing in alternatives like hedge funds has become almost essential since beta returns are near zero. The fact that insurance companies are well-regulated entities, that almost brings us down a different track. Our investments are regulated by risk charges, and hedge funds are still regarded as high-risk investments, notwithstanding the actual volatility of hedge funds, which is much lower than equities as an asset class. However, hedge funds still attract more punitive risk charges. So, when we invest a dollar in a hedge fund, the return expectation is multiple times that of a dollar invested in fixed income or even equities. As a result, we have to really be careful about who we invest with. You have to really want to make the investment, which raises the need for deeper due diligence. You really need that dollar to fight for you.
One knock against hedge funds has always been that they lack transparency. Is that something that concerns you with Asian hedge funds?
Ai Ning Wee: We are an asset owner, first and foremost. We don’t have a dedicated desk that does operational due diligence, for example. So, you’re right, transparency and governance are concerns, and we find that the standards vary significantly across the spectrum. That’s what we like about a fund of funds approach. A firm like UBS HFS that has been engaging with Asian hedge funds for many years will have built up a reasonably strong network with cross-referrals and the like. That goes a long way in boosting the standards of hedge fund transparency in the region. So far, I’ve been very happy with the returns provided by fund of funds. Even in the midst of COVID-19, we’ve had no issues with Asian hedge funds engaging in lock-ups or side pockets or dropping returns.
It sounds as if that’s a little more practical than pursuing relationships with individual hedge funds if you don’t have the due diligence capacity.
Ai Ning Wee: It is, but that said, in Singapore there have also been a number of new hedge funds being set up by ex-managers from the big names. The ecosystem is actually very active in Singapore, and conversations are going on all the time. I cannot say the same of the China-based hedge funds because we don’t have that same proximity. If you’re based in Hong Kong, as UBS HFS is, there are more proximity benefits in China, and my guess is the ecosystem there has its own life and nuance. Being based in Singapore, I have no pretension that I can access the same kind of information on Chinese hedge funds as I could were I in Hong Kong.
How do you feel about the potential of Asian hedge funds looking to the future?
Ai Ning Wee: I think we are just on the cusp of takeoff. For the longest time, Asian wealth holders have been reluctant to invest in their own countries or region. There was inevitably a preference for the larger institutional names in the U.S. and Europe. 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 an increasing acknowledgement that there is hedge fund talent in Asia, and a willingness to put money with them. That’s very positive. If the performance is as expected, I see Asian hedge funds as a huge growth area.
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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).
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
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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. Based on historic risk and return characteristics, we believe that these strategies are likely to provide strong diversification benefits.”
“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.”
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 Hedge Funds for Investors Who Demand Transparency
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 HFS selects the funds it invests in – and how those funds are themselves managed.
Before he joined UBS HFS, Oliete, was at a single-manager hedge fund. “We didn’t share anything at that time,” he says. “But I’ve seen an evolution in my time on this side of the fence in a multi-manager hedge fund. Our size and scale at UBS HFS help. Hedge funds view us as a trusted partner, so we do get all the transparency that we require for our own decision-making and on behalf of investors.”
Transparency is a bit like data in that once you have it, what matters most is what you do with it. If a hedge fund holds 1,000 securities for example, it’s not especially relevant to have thorough insight into each of them. It’s more important to understand the holistic risk.
“We aim to understand the risks at a portfolio level, in terms of exposure and attribution of where the returns are coming,” says Oliete. “Conditional investments from us are dependent on that type of transparency, and that’s negotiated ahead of time. We’ve had to work very hard on that over the last five or six years in the region because transparency has been viewed as a bad thing for a long time – you don’t know where information is going, and you don’t really trust what people do with that information. Once the hedge funds understand who we are and what we do with that data, and how tightly we control that data, we receive transparency. And we provide our investors with a lot of aggregated risk and exposure metrics. Generally, we receive position level data from some managers, but in most cases we collect data on the top positions that have the potential to move the needle.”
Oliete says he and his team have a bias to invest in managers that are locally-based, mostly in Mainland China where they pursue substantive research themes bolstered by visits to companies and factories – in other words, hedge funds that really dig into the weeds.
“We focus on managers that have large research capabilities and ideally are based in Mainland China so they can easily access those companies,” he says. “We’re underwriting the strategy, portfolio and risk management, and also the people at the hedge fund and how knowledgeable they are. We meet with the management, analysts – we want to know the whole team at the hedge fund.”
Educating hedge funds
As the number of hedge funds in Asia and Mainland China increases, Oliete and his team find themselves investing time in educating the principal players at the funds on matters such as the operating infrastructure of the firm and running a business beyond investments.
“We want to be certain that the funds are set up for success as companies and capable of handling the sophisticated needs of institutional investors, which is something that has taken a little bit of time in the region,” Oliete says. “Sometimes when you look at the hedge fund industry in Asia as a whole, it’s obvious that it has developed very quickly. There’s still work to be done. However, funds appreciate our partnership because we provide that expertise and share the necessary nuance of what it takes to appeal to institutional investors, and what those investors expect in a fund.”
Oliete is impressed with the talent pool at Asian hedge funds, but his team does expect a fund to accept that there is room for improvement when it is pointed out to them, and will commit to that improvement over time if they want to work with UBS HFS.
“It’s important that we not compromise very high bar that we have set for operational due diligence at UBS HFS,” says Klingenberg-Timm. “We don’t shy away from saying no to a hedge fund if we’re not comfortable with some of the principals, or if they’re unwilling to implement what we suggest is necessary for them to grow into the institutional space.”
Within UBS HFS, a separate team focuses on operational diligence in order to avoid conflict. “If I really like something from an investment perspective, I cannot be the one to judge the hedge fund’s infrastructure, operational controls, and so forth. It doesn’t matter what I think – if the hedge fund doesn’t pass the standards set by that team, we don’t invest at that time. We don’t necessarily walk away – we help them try to fix it before so we can invest without compromising our standards.”
“The desire for hedge funds to go with a partner that applies global standards when it comes to due diligence and best practices matters enormously,” says Klingenberg-Timm. “I think that’s one reason why investors will rely more on partners like us to actually invest into hedge funds and in Asia. It’s a huge market, but some of the standards are still developing because these funds have not been around for 20 years. Maybe not even for 10 years, and global institutional standards are not always applied from the start. Sometimes they can’t be because the asset base is simply not big enough to warrant such a setup. We understand that, but we need to see that the willingness is there to reach the institutional level that we would like to see in any global fund we invest in.”
The give and take with hedge funds, and the willingness to educate willing students as it were, is “probably what some investors will be looking at when they decide that they’d rather access the opportunity in Asia through us rather than working directly with the hedge funds,” says Klingenberg-Timm. “In fact, we have some large sovereign clients in APAC that do know where to find these funds, but they do not want to do the operational due diligence on their own. They’d rather defer to a team with a global platform, and with people who do this every day all around the world.”
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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).
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.
1 Wind, CSRC, CIRC, NSSF, UBS-S. As of June 2019.
2 World Development Indicators (The World Bank), UBS, as of 30 April 2019.
3 Sales/transfers source: York Capital, Citi Research, May 2019; Share buybacks source: York Capital, TSE/Holt data as of June 2019.
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