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The Challenge of Attracting Capital from Japanese Pension Funds in Hedge Funds – April 2013

by Ivan Jincheng Han

  • 29 Apr 2013
  • HF

In December 2012, we looked at how Japanese hedge fund managers are facing new challenges after the industry was rocked by numerous scandals during 2012. Foremost among these was the AIJ Investment Advisors scandal, which impacted mainly domestic pension fund investors and severely impacted the confidence that Japanese pension funds held in the asset class.

Going forward, it is likely that the operating environment for fund managers seeking institutional capital from Japanese pension funds will be more difficult, with investors and regulators paying closer scrutiny on them. However, Japan is a key source of institutional capital in Asia-Pacific, with Japanese investors making up over 31% of the Asia-Pacific hedge fund investor pool and contributing nearly 35% of the total institutional capital that these investors allocate to the asset class. Pension funds are also the largest single group of hedge fund investors by type in Japan, making up nearly 54% of all domestic investors in the asset class by number. As such, fund managers looking to take a share of capital commitments from Asia-Pacific will do well to adapt themselves to the changing investor climate in Japan.

Poor performance of these traditional markets as well as changing funding needs has led to Japanese pension funds shifting their allocation from core Japanese bonds and equities holdings to alternative assets in search of a higher yield and greater stability of returns. With the advent of quantitative easing by the Japanese government, leading to a rising stock market, and with an increased wariness towards hedge funds, local pension funds are taking a more careful stance when investing in alternatives.

As such, it is increasingly vital that hedge fund managers meet these pension funds’ requirements for transparency and accountability, while providing products that meet the preferences of these pension funds in order to garner investments from them.

What are these investors looking for when they invest in hedge funds? In terms of structural preference, 77% of Japanese pension funds actively express an interest in commingled direct hedge funds; this is followed by commingled funds of hedge funds which is favoured by 42% of these investors.

Strategically, the more liquid hedge fund strategies are proving to be the most sought after among Japanese pension funds. Long/short equity funds are the most favoured of these, with over 32% of the investor pool expressing interest in the strategy. This is followed by macro (29%) and managed futures/CTA (29%). Asia-Pacific-focused hedge funds are also favoured, as Japanese pension funds indicate a preference for a core Asia portfolio. Sixty-five percent of these investors are looking to invest in Asia-Pacific itself, while 52% of Japanese pension funds will maintain a global outlook, with 15% seeking exposure to North America.

Although Japanese pension funds are more wary when investing in hedge funds following the AIJ scandal, they are still a key growth area in terms of institutional capital flowing into hedge funds. As many Japanese pension funds still maintain a core allocation to alternative assets, there is great scope for hedge fund managers to attract some of this capital with the promise of higher yields, as long as they can prove that they have strong institutional infrastructure and robust risk management procedures in place.

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