Alternative Investment Management Association
PwC Hong Kong
Asia’s hedge fund managers are facing a dilemma. Operating from the world’s fastest-growing economies, with a broadening array of financial tools available to them, they have a strong investment story to tell. Yet in order to become billion-dollar managers they need to raise assets from international institutional investors, many of them from the US and Europe, which expect the high standards of ‘trust and transparency’ typically associated with the largest international asset managers.
In recent years, and especially since the credit crisis, large institutional investors such as pension funds, insurance companies, sovereign wealth funds and endowments have become the biggest hedge fund investors. These institutions are increasingly adopting a ‘trust, but verify’ mentality. In other words, they will trust hedge fund managers with their capital, but they will also want to verify the claims made by these managers in their marketing presentations and regular communications.
Institutional investors are requesting higher standards of governance and controls worldwide. Demonstrating the move towards uniform practices, the Hedge Fund Standards Board (HFSB) announced a drive in February 2012 to extend its support in Asia and North America. Backed by more than 50 of the leading international investors in hedge funds, the HFSB aims to create a framework of transparency, integrity and good governance.
Perceiving a gap between the expectations of the world’s large institutional investors and the reality in Asia’s young hedge fund sector, PwC set out in the autumn of 2011 to interview organisations from across the region’s value chain1, to discover to what degree these factors are influencing the fortunes of managers. We then polled delegates at our PwC Asia-Pacific Alternative Investments Conference in Hong Kong and Singapore in November 2011. What we found was a wide divergence in ‘trust and transparency’ standards between different hedge fund managers.
Our research shows that some Asian hedge fund managers are rising to the challenge. They are building fund governance and firm infrastructure that match up to the most exacting international institutional requirements. They and their service providers are backing this with the transparency that allows investors to verify performance, asset information and operational controls. As a result, the region’s hedge fund sector is polarising, and a small number of managers command a disproportionate amount of assets2.
Yet Asia is different from other parts of the world. Precisely because the market is relatively young, and investment prospects relatively attractive, some investors are likely to accept higher levels of operational risk than they would elsewhere in the world. Asian high-net-worth investors are growing in number and are willing to accept operational risk; equally some institutions recognise that smaller managers have to control costs. Even so, in the past few years the new managers that have built sophisticated infrastructure have tended to reach US$1 billion in size more quickly than others.
A small group of managers has successfully combined strong performance with institutionalised infrastructures, governance and transparency. These managers have realised the importance of meeting the governance and transparency demands of the pension funds, endowments, sovereign wealth funds and others that increasingly are the sector’s dominant investors.
Changing investor base
Like hedge funds in other regions, Asian hedge funds are increasingly reliant on institutional investment. According to Deutsche Bank’s Alternative Investment Survey 2012, institutions account for well over half of investors in Asian alternatives funds by number. What’s more, the 2011 Preqin Global Investor Report Hedge Funds confirms that institutional investors have been increasing their allocations to hedge funds globally in the past five years.
Changes in source of hedge fund capital over five years
Source: 2011 Preqin Global Investor Report: Hedge Funds
While Asian institutional investors – such as superannuation funds and sovereign wealth funds – are growing in size, European and US investors still account for over half of total allocations to hedge funds in Hong Kong, the largest Asian hedge fund centre. According to the Hong Kong Securities and Futures Commission’s March 2011 hedge fund survey3, US investors made up 36.1% of allocations and European investors represented 24.3%.
The West’s pension funds are upping their allocations to Asian alternative investments, and there is no sign of this abating. They are diversifying from their home markets, where returns are expected to be low, seeking investments offering exposure to Asia’s superior economic growth.
Looking to the future
Going forward, this means Asian hedge fund managers need to identify and target specific investor bases. If they wish to raise institutional money, they will need to make the necessary investments in infrastructure and controls, while also providing sound fund governance. They will need to demonstrate the measures they have put in place through greater transparency.
Data from our PwC Asia-Pacific Alternative Investments Conference in November 2011 showed that smaller managers without the scale to build ‘institutional’ type infrastructure realise this and are seeking capital from Asia’s new wealthy. Some 44% of delegates viewed high-net-worth individuals and family offices as their most important investor bases. A further 38% saw institutional investors (including sovereign wealth funds) as their primary investors, and 18% were looking to fund of funds.
As Asia’s fast-developing economies create a burgeoning class of potential high-net-worth investors, so regional managers might choose to avoid building ‘institutional’-type infrastructure. But managers that don’t have institutionalised infrastructure are subjecting themselves to various operational and compliance risks.
 We interviewed approximately 20 organisations, including Asian hedge fund managers, investors (funds of funds, pension funds and endowments), administrators, prime brokers, consultants and industry associations
 Asia’s 10 largest hedge funds manage about 30% of $144.65bn hedge fund assets at end June 2011, AsiaHedge
 Report of the Survey on Hedge Fund Activities of SFC-licensed Managers/Advisors, March 2011Back to Listing