Asia-Pacific pension funds appear keen to embrace an increasingly popular strategy that lets them manage more of their money using the same tools as hedge funds, say Merrill Lynch executives.
The "130/30" strategy lets traditional long-only managers sell short up to 30 percent of the value of their portfolio, then use that cash to buy more stocks they think will do well. This offers higher returns than normal if fund managers choose correctly, but risks a more serious downside if they get their picks wrong.
"We're seeing enhanced interest in these sorts of products in this part of the world. Our belief initially is that we'll see the greatest level of demand in both Japan and Australia," Harvey Twomey, head of Pacific Rim equity financing and sales for Merrill Lynch, told Reuters. "We see this as being potentially revolutionary in terms of bridging the divide between traditional asset management and hedge funds."
Merrill recently hosted an information session on the strategy in Japan, drawing a stronger-than-expected audience of more than 120 clients. Leverage and short selling are tools that hedge funds have used for decades as they try to deliver absolute returns in all markets. By comparison, the focus of traditional long-only funds is to beat a market benchmark.
Merrill Lynch reckons about $50 billion in assets world-wide are currently managed using 130/30-type strategies, mostly in the United States. This compares with $1.3 trillion invested in hedge funds globally, and $10 trillion in US mutual funds. Managers to have launched 130/30 funds or a variation of them include UBS, State Street Corp and ING.
Some hedge fund managers are also involved. D.E. Shaw & Co, ranked last year as the world's third-largest hedge fund manager, last August launched a "130/30 fund" in its traditional long-only asset management arm. The strategy has its sceptics. Watson Wyatt World-wide, which advises pension funds on where to invest, has warned Asia-Pacific clients to be cautious, and is not recommending they put money into the strategy.
"You're definitely magnifying the risk within the portfolio, and you're magnifying correlated risk at that. You end up with exaggerated performance, which obviously goes both ways," said Scott Lothian, head of manager research for Asia ex-Japan at investment consultant Watson Wyatt. "I think it probably will get some interest, but I think there will come a crunch when people will see that when it goes wrong, it goes wrong pretty seriously."
Lothian said one problem is many traditional long-only fund managers lack the skill and experience to successfully sell stocks short. Because of this, he said investors looking for exposure to the alternative market would generally be better off investing in a hedge fund.
But many institutional investors are constrained in how far they can invest in alternatives such as hedge funds, and 130/30 funds offer another route, said Merrill Lynch director Kirstin Hill. Hill works Merrill's strategic solutions group in New York, which helps funds and investors implement 130/30 mandates.
Merrill is one of several brokerages working with asset managers to develop funds managed using the strategy. Such mandates can boost brokerage revenues because in addition to traditional buying and selling of shares, they also involve the share lending or creating of synthetic financial instruments used in short selling. "There are two angles to the opportunity here in Asia. There's the distribution of the product to Asian-based clients, but it's also taking Australian or Japanese or pan-Asian content ... and distributing it globally," Hill said.
Japan and Australia are expected to see strong demand for the strategy because of their large pools of pension fund money. Japan had more than $3 trillion in pension assets at end-2006, while Australia had about $743 million, according to a recent Watson Wyatt World-wide report.
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