A rough year for Asian hedge funds in 2011 exposed the long-only bias of many managers' portfolios, leaving the industry fighting a tough battle to retain clients as assets shrink and fund closures accelerate.
The setback puts at risk the industry's slow recovery since 2008 and highlights the need for the survivors to reinvent themselves in Asia, where lower market turnover makes some of the trading strategies used by hedge funds in the United States and Europe harder to replicate.
Net outflows in each of the last four months of 2011 have pushed the industry $52 billion behind its peak assets of $176 billion hit in December 2007, data from industry tracker Eurekahedge showed, spelling troubles for start-ups, prime brokers and other service providers who had pinned hopes on a potential expansion.
Well-known funds such as $300 million Thaddeus Capital and more-than-a-decade-old Boyer Allan Investment Management, which once managed $1.8 billion, have shuttered as the number of closures surged past launches for the first time since 2008.
Months ahead are likely to see more closures as investors punish underperformers and fund managers reassess future plans after four tough years -- Eurekahedge estimates nearly seven in every 10 Asia funds are below "high water mark", or their peak net asset values above which they can charge performance fees.
"It reflects a turning point for the industry," said Aradhna Dayal, head of Asia at industry tracker HedgeFund Intelligence.
"Barriers to entry are the highest ever, the road to closures is steep and slippery, and business sustainability is a key concern," said Dayal, who estimated 67 Asia focused hedge funds closed in 2011 versus 58 launches.
Hedge funds typically charge 2 per cent management fees and 20 per cent performance fees, largely on the promise that they will produce positive returns during upturns and downturns.
But a correlation of monthly returns of Eurekahedge's Asian hedge fund index and the MSCI Asia index in the last three years ending 2011 stood at 0.92, suggesting managers were unable to extract much bang for their investors' buck.
A figure of 1 indicates direct correlation.
"They do short but they tend to be long-biased. It would be rare for them to go market neutral or go net short," said Daniel Wang, chief investment officer of Hong Kong-based fund of hedge funds Vision Investment Management.
Short-selling strategies can be harder to pursue in Asia than in markets such as the United States, due to a smaller pool of securities available to borrow and lower market turnover.
The total pool of stocks available to investors to borrow in Asia stands at about $664.8 billion, which is about a fifth of what is available across Europe and less than a 10th of that in the Unite States, according to Data Explorers.
2011: Another Bad Year
Last year, hedge fund lost about 4 per cent as Europe's debt crisis, a sluggish US recovery and events such as Japan's nuclear disaster combined to create a tough trading environment.
Those investing in Asia lost 8.5 per cent on average, recording their second annual loss in four years, according to Eurekahedge, as largely long biased portfolios failed to absorb market shocks.
That has led to investors pulling out from funds, resulting into closures and shrinking many hedge funds to an asset level which makes it tougher to remain afloat at a time when rising regulatory and compliance burdens are adding to the cost.
The list of closures include Singapore-based RSR Capital and British-based Wessex, which closed its Asia-Pacific fund, while Singapore-based Komodo Capital has liquidated its flagship global macro fund KC Asia.
FRM Capital Advisors has pulled out of Hong Kong-based Isometric Investment, a hedge fund started by former head of Goldman Sachs' Asia equity trading desk Sanjiv Bhatia that it seeded in 2009, Patric de Gentile-Williams, chief operating officer of FRM, told Reuters in an e-mail.
"We'll see further attrition this year, of managers closing, or going private, or joining platforms or other large managers," said Peter Douglas, founder of hedge fund consultancy GFIA.
"We'll also see plenty of start-ups as traders leave banks' shrinking proprietary activities, and there are seeding deals out there looking to capture some of the hedge fund margin, but I'm sceptical as to the extent they'll raise further capital."
Barclays Capital expects about $80 billion of new assets to flow into the global industry in 2012, with investors likely to reallocate about $300 billion of existing assets within and across hedge fund strategies.
"The problem for Asia, where we see the noise of negativity about hedge fund closures, is going to be dominated towards the equity long/short space," said Ryan Bacher, head of prime services for Barclays Capital in the Asia Pacific.
He said macro/credit funds should get flows but there was "a real question mark right now given the last two years on how structural, fundamental, value investors make returns as opposed to applying a trading philosophy through volatile markets."
Both Boyer Allan Pacific fund and Wessex Asia-Pacific funds were long biased. About 40 per cent of the assets invested in Asia is parked in the long/short strategy, making it the biggest hedge fund category, according to data from Eurekahedge.
As funds look for ways to attract new investors, some are even cutting fees.
For example, Singapore-based Kingsmead, founded by former FrontPoint portfolio manager John Foo, is offering fee discounts to initial investors as it seeks to grow assets in a tough capital-raising environment for its new hedge fund expected to start trading on March 1.
The Asian industry never fully recovered from shocks in 2008 and 2009, when more than $40 billion left regional hedge funds and nearly 300 funds shut down, data from Eurekahedge showed.
Some of the money was recycled back and start-ups such as Senrigan Capital, run by former Citadel trader Nick Taylor, and former Goldman Sachs trader Morgan Sze's Azentus have become Asia's post-2008 class of relatively few $1 billion hedge funds.
Senrigan lost 8.6 per cent while Sze's hedge fund fell 6.8 per cent last year.
But the local industry remains vastly dominated by smaller funds that lack the scale and infrastructure to absorb capital from the Europe and US based institutional investors who now contribute the most to the growth of the industry globally.
As more funds close down in the region or lose assets, investors are likely to tilt towards allocating capital to familiar and large global hedge funds with Asia exposure.
"In times like this, the big ones get bigger and particularly the global ones get bigger," said the chief of an Asia-based hedge fund that shut down recently.
The industry is expected to see new launches such as the one from Eashwar Krishnan, a former analyst at Lone Pine Capital, who has teamed up with Tanvir Ghani, former head of capital intro for Asia-Pacific at Goldman Sachs.
Others like Alp Ercil, a former partner and the head of New York-based hedge fund Perry Capital's Asia operations, and Morgan Stanley's former head of fixed income for Asia-Pacific, Ranodeb Roy, are also preparing to launch their funds.
But the buzz that existed same time last year is missing.
"Do you really want to be launching a new fund right now, particularly if it's going to be on the smaller side knowing that the opportunity to raise any money right now is severely limited?" said James Fallon, director, financing sales in Asia Pacific, at Bank of America Corp.
"Unless you have got backing and you are able to launch with a bare minimum of 20-25 million, I have a feeling that a lot of prime brokers won't be all that interested."