Is the recent upsurge of hedge funds entering into Japan a sign of positive response towards the policies under ‘Abenomics’?

Thomson Reuters, and various news wires reported on November 15, 2013 that hedge funds from all over the world including those coming from New York, and London, were flocking to Japan, which has seen an increase in foreign capital inflows since Prime Minister Shinzo Abe took office in early January 2013. It has been a huge turnaround for Japan, especially when it had underwent a significant slowdown in economic growth for the past few decades. The Nikkei 225 index broke through the 15,000 mark on Nov. 15 to end the trading session at 15,166. This marked a significant milestone for the year-to-date (YTD) performance in the Japanese equity markets. The index was last traded at approximately 15,500 to 15,600 levels during early Asian trading hours on November 22, 2013. The index is currently trading at approximately 20.0 to 21.0 times trailing price-earnings (P/E) multiple, and it seemed quite expensive compared to the approximately 15.0 to 16.0 times P/E multiples for the US S&P 500 index, and the approximately 10.0 to 11.0 times P/E multiples for the Mainland Chinese stock indices. The rise in the equity markets in Japan has been propped up mostly due to the weakening Japanese Yen currency, which has benefited many Japanese exporters, including the automobile manufacturers including Toyota Motors. The Japanese Yen has been weakening since November 21, 2013 and is now trading at approximately the 101.0 to 102.0 handle against the US Dollar. This comes after the comments made by Bank of Japan (BOJ) Haruhiko Kuroda that the central bank will continue with its massive bond buying programme, and inflation targets remained unchanged at 2.0 percent, though there has been a debate among many private sector economists regarding the time horizon set in order to hit the eventual 2.0 percent mark, given the stubbornly low inflation levels many Japanese people, and businesses have exprienced in the past.

The Nov. 15 Reuters report highlighted some of the major plus points that most hedge funds find reasonably comfortable putting their capital into the Japanese financial markets, including the expected stimulus measures that are bolstered by the so-called ‘Abenomics’; the comprehensive reform plans being laid out by Prime Minister Abe and his Cabinet, namely Fiscal, Monetary and Structural, commonly termed by many as the ‘Three Arrows’, among others. According to a survey of hedge fund firms conducted by one of the well-known research firms in this field, Eurekahedge, the proportion of capital invested in Japan by global macro funds being sampled showed that return performance from investments made in Japan rose by approximately 9.0 percent during the month of September 2013, up from 5.4 percent a year earlier. This is considered significant, if the percentage performance is adjusted for inflation. Country funds which have a Japanese focused theme have reportedly seeing a gradual increase in investor capital, albeit slowly.

According to the Nov. 15 Reuters report, capital outflows from Japan in the past have been rapid, with data showing that during the period between June 2012 and May 2013, net outflows coming from most of the Japan-focused funds amounted to approximately USD 4.0 billion, but lately during the last four months since August 2013, investor have pumped in approximately $340.0 million to these funds, and total assets under management (AUM) have increased to approximately USD 15.0 billion from USD 14.4 billion during the start of the year. This data was compiled by Eurekahedge.

Man Group, LLC, a United Kingdom (UK)-based fund management firm disclosed in October 2013 that its Japan strategy funds added approximately USD 2.3 billion between April and September 2013. The number of fund closures has also been declining with three being shut down, compared to twenty-one in 2012. This represents one of the lowest numbers of closures since 2004. Eighteen fund firms were reportedly launched this year versus nineteen last year, and there could be more in the pipeline.

However, despite the hype over Japan’s long-term prospects, several hedge fund managers have expressed some caution over the rapid pace of fund inflows and the rise of the Japanese equity markets. The fundamentals are generally looking more positive these days, along with the ongoing stimulus coming from the monetary reforms side of ‘Abenomics’, but going forward in 2014 and beyond, several issues could continue to hamper Japan’s recovery, including the expected increase in the consumption tax to 8.0 percent, up from the present 5.0 percent come April 2014; the persistent weak current account balances as shown by this week’s October 2013 trade data which recorded a massive trade account deficit; the overall debt to total Gross Domestic Product (GDP) still at relatively high levels at approximately 200.0 over percent; the slow implementation of the ‘Third Arrow’ or structural reforms needed to boost the economy such as tackling the aging population issues; pace of the clean-up efforts by the Japanese authorities over at the crippled Fukushima Nuclear Site, which was devastated by the country’s worst Tsunami disasters in March 2011; among many others .

These issues do have a significant impact in many of the investment decisions made not only by hedge fund investors, but other potential investors seeking to invest in Japan. Reuters reported that despite the onrush of several international hedge fund firms into the country, the number of Japan-oriented funds, including those based in the capital city, Tokyo, or larger fund centres such as Hong Kong and London, is a fraction of what it was ten years ago. According to research done by another well-known firm, Hedge Fund Research (HFR), which also trademarks its proprietary index called Hedge Fund Research Composite Index (HFRI), showed that between 2006 and 2012, Japan-focused funds made money in two years, and lost an average of two percent per annum. Incidentally, according to a November 13, 2013 news report by Thomson Reuters, data obtained for the month of October 2013, and reflected by the SS&C GlobalOp Hedge Fund Performance Index, the average fund returned approximately 1.06 percent in October 2013, bringing the gains earned by the hedge fund industry to approximately 9.93 percent. With less than a month away to the end of 2013, the general performance achieved so far by most hedge funds is strong, but it is still lagging behind most of the equity indexes, with the MSCI World Index rising by approximately 22.5 percent. Despite the relative lacklustre performance compared to most of the broad market equity indices, most hedge fund managers will generally be satisfied in accepting this level of performance achieved so far, as many parts of the world economy are still on a slow recovery pace following the Global Financial Crisis (GFS) in 2008-2009, and the ongoing slowdown in economic growth seen in some parts of Asia such as Indonesia, Europe, and the BRIC economies of Brazil, Russia, India, and China.

Japan has been a long forgotten investment location for many hedge fund managers seeking to open up offices there, It still remains to be seen whether in 2014 and beyond, the country will be able to attract more hedge fund firms, as policies under ‘Abenomics’ are just taking ground, and progress towards achieving the reforms outlined by Prime Minister Abe is still relatively mixed, and some hedge fund managers have expressed their doubts over implementation issues, and question whether the recent upsurge in foreign capital inflows, including those coming from the hedge fund managers are just part of their tactical moves, which could be interpreted as short-term in terms of the investment horizon.

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