Stars aligned for Japan hedge funds

NICK Bird’s OQ Funds Management opened a Japan quantitative hedge fund last September.

Within weeks, it raised the maximum US$250mil and had to turn away additional money, the former Macquarie Group Ltd veteran says.

Meanwhile, Sengu Capital Ltd’s hedge fund tapping improving corporate management in Japan has tripled assets to US$450mil after trading began in early October, say people familiar with the Hong Kong-based firm.

A multi-strategy Japan fund that York Capital Management spinoff MY.Alpha Management opened to external clients in early 2023 now oversees about US$700mil.

Their pace of asset gathering, impressive for Asia hedge funds of any stripe these days, highlights how Japan’s deepening corporate governance reforms and exit from more than a decade of deflation have rekindled global investor interest in the world’s fourth-largest economy.

It also underscores the dearth of Japan-dedicated funds that have good track records and are able to take sizeable amounts of money from large institutions. 

“Despite the increased interest in Japanese hedge funds, allocators have been starved of institutional-quality, scalable managers,” says Michael Garrow, chief investment officer of HS Group, a provider of strategic capital to fledgling hedge funds, including Sengu. 

Japan was once a magnet for hedge funds, drawn by opportunities as wide-ranging as currency and rates to convertible bonds and stock index rebalancing.

By the early 2000s, there were more multibillion-dollar hedge funds focused on the country than anywhere else in Asia.

Then it fell out of favour, hurt by crackdowns on insider trading, the global financial crisis and the 2011 earthquake and tsunami.

At the same time, capital market reforms made China a more accessible market.

Now the stars are aligned for Japan hedge funds again. Inflation is back, along with wage growth. Through the turmoil triggered by the Trump administration’s tariff policies, Japanese stocks have largely held onto gains in recent years.

In US dollar terms, the benchmark Topix index chalked up an annualised 8.4% return in the past five years, against the 0.1% loss of the MSCI China Index.

A net 22% of respondents to a BNP Paribas SA survey last year expected to allocate more money to Japan, the second-most sought-after geography. This year, 20% indicate similar plans.

The foremost beneficiaries of the renewed Japan interest have been funds that have taken a page from their activist predecessors, engaging with companies to push for improved shareholder returns, governance reforms and capital efficiency.

The paucity of in-depth broker research on Japanese companies leaves hedge funds ample space to mine hidden gems.

Nearly one-third of the 1,684 companies in the Topix are not known to be covered by analysts, compared with under 5% of those in the similar-sized S&P 1500 index, according to data compiled by Bloomberg. 

Some veterans are seeking to capture the renewed interest. Convertible bond trader Chris McGuire shut down his 15-year-old hedge fund in 2020 when new issuances plunged.

Last September, he returned with a new Japan fund with Neal Berger’s Eagle’s View Capital Management.

Former Soros Fund Management LLC trader John Zwaanstra’s Penta Investment Advisers Ltd has also been trying to capitalise on demand for Japan expertise, say people with knowledge of the matter.

Keita Arisawa morphed his then six-year-old Seiga Asset Management from an Asia hedge fund firm into a Japan specialist in 2023. 

There are also signs of a reviving startup scene, with more varied products on offer. Rogers Investment Advisors has seen 17 new Japan-focused hedge fund firms springing up in the past 18 months, says its chief executive officer Ed Rogers. 

Still, many traders have instead flocked to multi-strategy, multi-manager hedge funds. Global and regional pod shops such as Millennium Management, Point72 Asset Management and Hong Kong-based Polymer Capital Management have scores of Japan-focused teams between them, each numbering one to multiple employees, industry executives estimate. 

Such pod shops have absorbed the bulk of new money flowing into the global industry since 2017. For their clients, it marks a safer way to tap into opportunities without having to spend time researching managers in different time zones with language barriers and a cultural gap. 

Lack scale

Investors wanting pure Japan exposure or trying to sidestep the higher fees charged by pod shops have often been stumped because independent hedge funds lack scale.

Large international investors tend to allocate at least US$50mil to firms specialising in publicly traded securities, according to a 2024 survey by Fincity.Tokyo.

That makes it difficult to invest in smaller firms without accounting for a large portion of their assets under management, a level of exposure that many allocators prefer to avoid.

Having spent months or even years monitoring candidates, institutions also prefer managers who can potentially take larger amounts of capital from them over time.

As managing partner of Sussex Partners Ltd, Patrick Ghali has seen around 100 teams that traded Japan over 20 years. He reckons the typical Japan funds oversee US$50mil to US$80mil, often with only two or three employees.

Most would stop accepting fresh cash by the time assets hit US$300mil, given the risk of diminishing returns if the investment opportunity is finite, or because they focus on smaller, less liquid companies.

Since late 2023, Japan’s Financial Services Agency has been encouraging domestic banks and insurers to allocate money to fledging money managers, as part of a drive to promote the country as an asset management center. 

Still, local investors, especially institutions, have almost no interest in parceling out money to small Japan-focused hedge funds, Rogers said. Meanwhile, regulatory hurdles make it impossible to access mass-affluent Japanese clients, he added.

To bridge the gap, Ghali set up a new Japan multi-strategy, multi-manager hedge fund with local veteran Masahiro Koshiba, an early member of Japan Advisory Ltd, which once oversaw billions of dollars. The objective of the project – which is separate from Sussex – is bringing together teams that are, on their own, too small to get on the radar screen of larger international investors.

“Japan is one of the best, if not the best, hedge fund alpha markets,” Ghali says, referring to market-beating performance. “You have all these talented traders, but a lot of them are sub-scale. It would make a lot of sense to create some sort of product where the best can be combined.” — Bloomberg