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Asia Pacific Intelligence

"Ignore Japanese alpha at your peril" says GFIA

Tuesday, April 09, 2013

(This piece first appeared in Opalesque's AMB.)

GFIA addresses the subject of the resurgence in hedge funds in Japan in this month's issue of their research insights, asking is the recovery rational, or a false signal?

Peter Douglas

"Compared with when we last visited the topic two years ago, Japan seems to have regained investors' attention; it might even become a pain trade, too important to omit in the context of a global portfolio. Bloomberg reports that "the rally in Japanese stocks since new Prime Minister Shinzo Abe... is starting to stir investor interest in hedge funds", and it certainly doesn't discourage that Eurekahedge has just reported the best three month performance on record for their Japanese hedge fund index through February."

In their quantitative research piece, GFIA looked at the Japan absolute return universe, and quantified some of the characteristics of the constituent funds over the years. "We note however a precipitate drop in the number of listed funds since our last Japan-focused study; our final universe consists of 96 funds, less than half the number listed in May 2011.

A grizzly market watcher might comment that when there's been an exodus of alpha seekers from a market, those that are left should have a field day."

Funds drawn from the AsiaHedge and GFIA's own database were divided into three categories: long-only funds, long-short funds and market neutral funds. They then examined three risk-return attributes - returns of funds vs benchmarks; correlations analysis and gross and net exposures of long-short funds.

GFIA found that the three strategies studied showed clear and expected divergences in return profile, volatility of performance and correlations. "Long short funds had the best total returns, although market neutral managers delivered the steadiest performance as return profiles diverged according to strategy directionality. All three strategies did better than passive benchmarked investing from a risk-adjusted perspective, clocking higher returns at far lower volatilities. Benchmark correlations for long/short and long only funds actually dipped during downward/sideways trending periods, a testament to the managers' stock-picking skills, while those of market neutral managers spiked worryingly. Net exposures were wide ranging, whilst gross exposures have expanded since the summer of 2012, culminating in a sharp uptick in January 2013."

GFIA concluded that there are plenty of interesting and differentiated Japanese propositions. Highlights to take away included:

1. Small-mid cap managers dominated the hedge fund space and contributed to most of the outperformance in long short equities strategy. This compares with the TSE Mothers index which was down for the period covered. Allocators would do well to focus on this part of the market.

2. Different sub strategies abound for long-only and-long short equity managers. We are seeing increasing influence of Japanese activism funds. There is good diversification within the Japanese manager universe.

3. Niche or deep value strategies focusing on: healthcare, sector consolidation themes, real estate refinancing deals, M&A arbitrage to name a few. Managers have strong informational edge due to long-standing experience and cultural reasons. Skill and experience do matter in Japan.

The firm concludes: "Nobody knows whether "this time it's for real" in Japan. While the renewed enthusiasm is certainly good for business, it may not necessarily be self-fulfilling or sustained. Half the deflationary battle (a psychological disease entails a similar cure) may already be won, if market sentiment continues to buoy domestic spending." "But from an allocators' perspective, this is a market representing the world's third largest economy; arguably its most innovative economy, with over 3,000 listed stocks, of which, conservatively, there might be sell-side coverage of 25%, and a minimal community of alpha seeking investors. Ignore Japanese alpha at your peril."

This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.
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