BNY Mellon expects strong demand for Asian hedge funds in 2011

Improved corporate governance in Asia could lead to greater institutional demand for the region's hedge funds

Institutional demand for emerging market hedge funds in 2011 is set to rise if corporate governance practices become more robust and provide higher levels of transparency, predicts BNY Mellon.

BNY Mellon said it expects a boom in institutional demand for emerging market alternatives in 2011 if corporate governance practices develop in the region.

Until recently investors have been wary of emerging markets due to volatility issues. This is particularly true of Asian markets. The HFRI Emerging Markets: Asia ex-Japan Index posted returns of 34.14% in 2007 which then nosedived to a negative 33.48% in 2008.

By contrast in the third quarter of 2010, the index gained 9.3% through October, outpacing the 6.8% gain of the broad-based HFRI Fund Weighted Composite Index, lending investors greater confidence to invest in the region.

BNY Mellon said the global low interest rate environment is stimulating demand for alternatives in emerging markets, particularly in Asia.

"The global low interest rate environment is driving institutional investors and pension funds to seek alternative sources of returns, driving an increase in appetite for alternatives in emerging markets, especially in Asia," said Andrew Gordon, head of BNY Mellon's alternative investment services.

"Large institutions, especially those in Asia... are focusing an increased degree of attention on hedge fund opportunities with increasing numbers of investors making their first investments in the alternatives space in the region and this is a trend that is expected to continue well into 2011," he added.

These institutions include sovereign wealth funds, pension funds and life insurance companies seeking better returns and portfolio diversification.

Gordon believes corporate governance practices will determine which hedge fund institutions decide to allocate to, listing the funds' investment track record, the business and operational track records of fund managers and the level of transparency they can provide to investors as the key deciding factors.

"We believe we will be seeing a more robust outlook and increased capital raising activities in those Asian hedge fund managers who have invested or are willing to invest in institutionalising themselves... building up the infrastructure of their business for greater transparency, corporate governance and risk management," Gordon commented.

As a result the amount of time and resources invested in due diligence procedures "is likely to accelerate in 2011 as a number of high-profile funds folded during the first half of 2010 and a multitude of insider trading cases emerged in the latter half", he said.

In late November 2010 the US Federal Bureau of Investigation (FBI) raided the offices of three hedge funds - Diamondback Capital Management, Level Global Advisors and Loch Capital Management - as part of a wider investigation into insider trading.

Recognising institutional demand for excellent corporate governance "will eventually and effectively differentiate winners from losers in the marketplace, specifically for those smaller hedge funds from the region", according to Gordon.

According to Hedge Fund Research nearly two-thirds of capital invested in Asian-focused hedge funds goes to equity hedge strategies. In the overall hedge fund industry, equity hedge represents less than one third.

Hedge Fund Research data showed China is the principal location for new funds, serving as the base for nearly 25% of all Asian hedge funds.

BNY Mellon is a global financial services company with $24.4 trillion in assets under custody and administration and $1.14 trillion in assets under management.

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