Why Japan hedge funds consistently beat equity benchmarks, a feat most other regions struggle with

Demand for Japan hedge funds is both slow and fast

What sounds like a KOAN is of course from the new Opalesque Japan Roundtable:
www.opalesque.com/RT/RoundtableJapan2017.html

Over the last five to ten years, there has been a hollowing out of the dedicated Japanese hedge fund community as many managers have moved offshore or toward a more Pan-Asian model. As a result, the market has been supply constrained and players on the ground in Japan say there is an appetite for emerging managers in spite of a difficult overall fund raising environment (page 6).

Since the financial crisis, Japan has seen its domestic hedge fund industry mature to a great degree. Around 2010/2011, the numbers of new launches outstripped the ones terminating, and right now, Japan is witnessing a proliferation and growth of platforms that help new managers to start up. This new generation of managers comes with more experience in hedge fund management and strategies, particularly shorting skills. Having managed money through different market cycles should put them in a better position to perform well over time (page 18-19).

Japan hedge funds consistently beat equity benchmarks

Says June-Yon Kim: "Just look at some data SPIVA, an unit of S&P Dow Jones, put out. They have done studies of passive versus active managers, and actually what happens in the US is what you read about all the time. So in the US for the year ending June 2016, only 10% of active managers were able to beat their benchmark for one year, and only 5% of the managers for five years.

" Interestingly, if you look at the Japanese data, and this is a pretty big sample, it’s something like 470 funds, at the end of June,

72% of active managers beat their underlying index, and over five years it’s 40%. These numbers are significantly higher

than in the United States. So again, going back to Japan as a market, it’s a great market for long-short stock pickers because

it there is a lot of inefficiencies and a lot of dispersion."

Investing beyond the Narrative

When historically investors were looking at Japan, they have always tried to look at it through some narrative as in the case with the Koizumi reforms, or this time around with Abenomics. Some of the "fast money" has been going to Japan activism or governance-focused funds which have become another new narrative. Equity flows into Japan generally tend to ebb and flow based upon how foreign investors feel about a particular narrative. However, Alex Kinmont points out that "these narratives are always wrong. They are irrelevant and wrong, but I accept that they are necessary." (page 7-9, 13, 14)

What most investors would miss is the fact that Japan is an extremely deep market with a lot of return dispersion , which is ideal for an investor who can go long and short. More and more investors will see Japan not so much as a directional trade, but more as an opportunity set where they can find managers who work as stock-pickers throughout the market cycle. Another evidence of that is the range of firms like Point72, Millennium and Viking which all have offices in Tokyo and are running large multi-manager portfolios. The more the hedge fund market can expand, the more it will incorporate more variable bias strategies (page 7, 10).

This Opalesque Japan Roundtable took place in Tokyo with:

Shinichiro Shiraki, AIMA Japan
June-Yon Kim, Portfolio Manager, Azabu Value Fund
Peter Douglas, CAIA Japan
Alex Kinmont, CEO, Milestone Capital
Yoshiaki Iizuka, Head of Research, Rogers Investment Advisors
Rory Kennedy, COO, Rogers Investment Advisors

The group also discussed:

Why is the demand for Japan hedge funds both slow and fast at the same time? (page 6)
How long does it typically take to obtain a full discretionary investment management license or type I &II securities license in Japan? (page 18)
Why do overseas investors often struggle when trying to identify Japanese hedge fund managers? (page 19)
Why was Japanese hedge fund industry’s “Lehman moment” actually in 2006 and not 2008? (page 8)
What can the world learn from the last 30 years of Japan’s economic history? What’s the true nature and causes of deflation? (page 22-23)

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