Have Japan-focused hedge funds thrived under ‘Abenomics’?

Bloomberg Online News reported on December 27, 2013 that based on data compiled by the Singapore-based Eurekahedge, several Japanese hedge funds came out tops in terms of alpha outperformance. According to the Bloomberg News article, two hedge fund firms, namely Stratton Street Capital LLP’s warrant fund, which delivered more than 300.0 percent return, while the Hayate Japan Equity Long-Short Fund almost doubled.

Along with the backdrop of record easing of monetary policies, and the various reforms being introduced that seek to boost investment flows, massive devaluation of the Japanese Yen (JPY) currency (which was said to have depreciated by almost 16.0 percent year-to-date against the major currencies, and was drawn from a quote made by one of the Bloomberg Television News presenters at the London desk during European trading hours earlier this week), efforts to boost consumer expenditures, increase industrial production, among others which have in some ways gave rise to the bullish sentiments seen among many investors in the Japan. This has translated into Japan-focused hedge funds being one of the top performers in Asia in terms of returns, and alpha outperformance.

Separately, a host of economic data was released in Japan during the early Asian trading hours on December 27, 2013. Some of the key takeaways included core Consumer Price Index (CPI) for the month of November 2013 rose to 1.20 percent versus the prior year of 0.90 percent (Reuters estimate of 1.10 percent increase); November 2013 household spending for the month of November 2013 increased 0.20 percent, versus the prior year of an increase of 0.90 percent (Reuters estimate of 1.70 percent increase); Japanese manufacturing Purchases Managers Index(PMI) came in slightly higher at 55.20, versus previous estimate of 55.10; Japan’s unemployment rate for the month of November 2013 ticked up slightly higher to 4.00 percent, versus Reuters estimate of 3.90 percent; Japan November 2013 retail sales increased 4.00 percent, versus the year ago figure of 2.34 percent increase (Reuters estimate of 2.90 percent increase); and Japan’s industrial production for the month of November 2013 increased by a mere 0.10 percent versus expectation s of a 0.40 percent increase.

With the release of the latest economic data, the Japanese Yen currency weakened further and was last quoted at an average spot rate of 104.84 – 104.88 (bid/ask), and the Nikkei 225 traded lower at 16,126.93, down by approximately 0.30 percent, or 47.0 points as of 1010 hrs (Singapore/Hong Kong time).

The plethora of economic data released this morning offered a mixed economic outlook for Japan, with improvements noted including some signs that Japan might be on the path of getting itself out of the decades-old deflationary cycle as measured by the slight uptick in the core CPI figures, and this improvement forms part of the key barometers closely watched by the Bank of Japan’s (BOJ) as it strives to achieve an overall inflation target of 2.00 percent by the second half of 2015. Retail spending has increased during the month of November 2013, but household spending is still lagging, and this could be due to seasonal trends such as the holiday spending. However, if household spending levels do not improve substantially, it could pose some challenges as this might also indicate that average wage levels could not keep pace with the gradual increase in overall inflation levels that could sustain the daily household needs. Manufacturing output in Japan is heading towards consecutive months of declines or sub-par increases, with PMI and industrial output for the month of November 2013 showing slight improvements, but not enough to make an overall impact towards the nation’s total production output. The disappointing manufacturing output is exactly what was reflected in the latest Tankan (Business Sentiment) survey released by the country’s Ministry of Finance (MOF) earlier this month which showed a mere rise of 9.00 for the current quarter (October 2013 to December 2013), versus the prior quarter of 15.20.

Coming back to the news article, I believe that part of the hedge fund outperformance could also be attributed by some improvements in the level of corporate transparency, and rise in shareholder activism as noted by recent corporate moves such as those initiated by famed hedge fund manager, Mr. Daniel Loeb, of Third Point Capital Partners LLC, who heavily criticised Sony Inc.’s overall business strategies, and the recent disclosures made regarding his firm’s increase of its stake in Softbank Inc. founded Mr. Masayoshi Son, who was recently in the spotlight over his company’s plans to acquire T-Mobile USA, which is the fourth-largest mobile operator in the United States after AT&T, Verizon, and Sprint. The active boardroom involvement by hedge fund managers such as Mr. Loeb might also be part of what has developed recently in the Japanese corporate world, such as the issues pertaining to protecting of shareholder issues, which was rarely seen as necessary, and often a taboo subject by many Japanese corporations for the past decades.

According to the Bloomberg News article, there are several key factors which might also suggest that Japanese-focused hedge funds might outperformed this year among its peers, including some of the external conditions that facilitate these hedge funds to thrive. The Eurekahedge Japan Index returned 12.0 percent in 2012, and was the worst performing index among five geographical region indexes tracked by the global data provider. In 2013, it gained 24.0 percent for the year through November, which compares well with the 7.0 percent advance in the global index, an 8.5 percent return by the measure tracking North American funds, and a 12.0 percent increase in the Asian index, excluding Japan. Among the index major outperformers were warrant funds, which benefited from an increase in convertible bond sales by Japanese corporations seeking to tap into the ultra-low interest rate environment. Japanese corporations have raised a combined JPY 631.0 billion (USD 6.0 billion) through convertible-bond offerings, the most since 2006, according to data compiled by Bloomberg News. The spill over effects through such trends observed among convertible-bond sales by Japanese corporations have benefited Hayate Japan Long-Short fund which has USD 50.0 million of assets under management (AUM), and focuses on companies with market capitalisation by less than JPY 100.0 billion yen and have relatively few research coverage on these equity names. This was referenced by of the Singapore-based directors at Hayate Parters Private Limited.

In summary, I believe that going to 2014, hedge funds could be facing with a multitude of challenges such as the upcoming introduction of the consumption tax hike to 8.00 percent by April 2014, and the uncertain manufacturing outlook in the country as shown by the various economic and private surveys which suggest possible manufacturing slowdowns in anticipation of the consumption tax hike. It appeared that the consumption tax hike in April 2014 might forestall the overall economic progress in Japan, but various statements issued by Prime Minister Shinzo Abe, and Bank of Japan (BOJ) Governor, Mr. Haruhiko Kuroda have tried to prove that the consumption tax hike might not be a significant threat to the gradual recovery of Japan. However, so far, my guess is few have been convinced and this was reflected earlier through those manufacturing and household spending numbers for the month of November 2013. Japanese-focused hedge funds which have made the country their home base might also be witnessing the gradual transformation of what was once being shunned by fund managers, to a new darling starting from 2013. Could the ever increasing Japanese equity markets be able to reverse on a down course in 2014? This sudden reversal of fortunes in 2014 remains to be one of the biggest risks which many Japan-focused hedge funds might be confronting as we approach towards year-end, and the start of the new year.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc