We’re in Asia for the next two weeks (Singapore, Hong Kong and Seoul), canvassing alternative investment professionals on last year’s annus mega-horribilis and finding out what got into the water that has led to this year’s miraculous rebound for both the hedge fund and long-only communities.
As the Economist reminded us last month:
The four emerging Asian economies which have reported GDP figures for the second quarter (China, Indonesia, South Korea and Singapore) grew by an average annualised rate of more than 10% (see article). Even richer and more sluggish Japan, which cannot match that figure, seems to be recovering faster than its Western peers. But emerging Asia should grow by more than 5% this year—at a time when the old G7 could contract by 3.5%. Western politicians should brace themselves for more talk of economic power drifting inexorably to the East. How has Asia made such an astonishing rebound?
Asian hedge fund managers are no strangers to volatility, however, as the chart below from HFN’s recent Q2 Asset Flow Extract reveals:
Perhaps some of the reasons behind this feast or famine experience lie in a recently-released paper on the risk factors that make up Asian hedge funds. In “Return based Analysis and Value at Risk of Asia-Focused Hedge Funds“, Haijie Weng and Stefan Truck of Macquarie University in Sydney find that Asia (ex-Japan) hedge funds can be explained by a set of mostly linear factors.
As you can see from the table below from the paper, three quarters of the volatility of the HFRI Emerging Market-Asia (ex-Japan) index between 1990 and 2009 can be explained using these factors:
As you can see, the non-linear factors (the out-of-the-money puts and calls) don’t have nearly as great an effect on the behaviour of the index as the equity and fixed income factors. Obviously, this equity exposure skewered many Asian hedge funds last year and have been a huge tailwind so far this year. Many Asian funds are long-bias long/short equity funds. So this makes a lot of sense.
In fact, this is very similar to what Singaporean academic Melvyn Teo found in his seminal 2007 study of Asian hedge funds. The table below from that paper confirms the lore that Asian hedge funds – specifically the same “Asia ex-Japan” index used by Weng and Truck – contain a significant amount of equity beta (click to enlarge).
But how high are these equity weights? After all, aren’t all long/short equity indices dominated by equity risk? If there is any surprise contained in Weng & Truck’s or Teo’s analyses, it’s probably that there are so many different factors involved in Asian hedge fund returns.