SHUHEI ABE HAS HIS SIGHTS SET ON ASIA. THE founder and CEO of Sparx Group Co., Japan’s largest hedge fund firm, has traditionally focused on his domestic market, but the downturn in Japanese stocks over the past year has hit the company’s portfolios hard. Sparx’s assets dropped a steep 25 percent last year, to less than ¥498 billion ($6.5 billion) by the end of December.
Abe believes diversification is the remedy to Sparx’s problems. He is recasting the firm as a pan-Asian fund manager. To that end, he dispatched the company’s chief operating officer, Masaki Taniguchi, to Hong Kong last June to expand the group’s office there and spearhead the search for investment opportunities — and investors — across Asia. “We have been realigning our firm to pursue our business on the premise that Asia, including Japan, is one seamless economic region,” says Taniguchi. “The additional allocation of management resources to Hong Kong demonstrates our strategic commitment to the region.”
Sparx is far from alone. These days fund managers are flocking to Hong Kong or expanding their operations there. The city’s deep capital markets, abundant talent and friendly regulatory environment are luring institutional investors
and alternative fund managers alike. Hong Kong’s easy access to the big Chinese market next door adds to the attraction, especially with authorities in Beijing moving to develop an offshore market in renminbi in the former British colony. As a result, this longtime banking and commercial hub can now boast of being a leading asset management center.
The number of money management firms in the city had risen to 798 at the end of 2010 from 580 three years earlier. Total assets increased more modestly, to HK$10 trillion ($1.3 trillion) from HK$9.6 trillion, but that occurred against a backdrop of weak markets that saw the MSCI Asia APEX 50 Index drop more than 11 percent during that period. The industry’s growth put Hong Kong well above rival Singapore and made the city the largest fund management center in Asia outside of Japan.
“We see more and more global asset management firms setting up office in Hong Kong,” says Jimmy Chan, CEO of Hong Kong–based Value Partners, Asia’s largest hedge fund, with $7.1 billion in assets under management. “Hong Kong is an international financial center with a well-established regulatory system and trading infrastructure.”
The buoyancy of fund management is part of a broader ascendancy of Hong Kong’s financial stature. The number of banking and financial businesses with regional headquarters in the city rose to 150 last year from 113 in 2007, according to Hong Kong government statistics. “Hong Kong has been entrusted with greater responsibility as a financial center by the global community since the financial crisis,” K.C. Chan, the government’s secretary for Financial Services and the Treasury, tells Institutional Investor.
The dynamism of Asian economies is the biggest factor in Hong Kong’s success. The region’s vibrant growth is attracting healthy flows of funds from investors in many sluggish Western economies and fueling the development of Asia’s own investor base.
“Growth in developed markets is likely to remain low in 2012, but we are positive on the outlook for Asia, which is supported by stronger fundamentals, particularly for China,” says Joanna Munro, Hong Kong–based CEO for Asia-Pacific at HSBC Global Asset Management. The firm, which manages $400 billion globally, runs most of its $60 billion in Asian assets from Hong Kong and has recently moved some of its key executives to the city. In August, Bill Maldonado, the firm’s global chief investment officer for equities, moved to Hong Kong from London and took on the additional role of CIO for Asia-Pacific. HSBC also appointed Patrice Conxicoeur as global head of insurance coverage, based in Hong Kong, to develop the group’s asset management business with major insurers.
Underscoring the growing investor interest in Asia, J.P. Morgan Securities (Asia Pacific) recently launched a new piece of investment software for the bank’s top 150 institutional investor clients around the world to help them identify investment opportunities in Asia. The software, JPM Interactive Models, allows fund managers to calculate the potential stock performance of more than 700 Asia-listed companies based on different performance scenarios. It is the first time the bank has introduced a global product out of Hong Kong, says Sunil Garg, J.P. Morgan’s Hong Kong–based head of Asia-Pacific research.
For many companies, the size and sophistication of Hong Kong’s capital markets and the strength of its financial infrastructure — including everything from a strong talent pool to a trusted legal and regulatory environment — make the city an ideal base for covering the region. Hong Kong is “one of the few truly international finance centers, based on regulatory support, talent, infrastructure and connectivity to the global world and China,” says HSBC’s Munro.
In 2011, for the third year in a row, Hong Kong led all other financial centers in terms of funds raised through initial public offerings. Companies reaped a total of $31.4 billion in 65 IPOs last year. That volume was half the $63 billion raised in 2010, but it still exceeded the $30.7 billion raised in 69 deals in New York, according to financial data provider Dealogic.
The local authorities have taken a number of steps to increase the attractiveness of operating in the city. In the past five years, the government has provided an exemption from stamp duties for certain exchange-traded funds — namely, those tracking indexes making up less than 40 percent of Hong Kong stocks. It has also established a network of agreements with 17 major trading and investment partners to eliminate double taxation. Those moves came on top of a number of established tax advantages, including no capital gains tax on the sale of shares of private companies, no tax on dividend income and no taxes on Hong Kong transactions profits for offshore funds.
Access to the giant market across the border is also driving growth in Hong Kong. The fact that the city is China’s gateway to global financial markets is the main reason Sparx is building up its office there. The Tokyo-based hedge fund firm, which employs 173 people overall, has 32 staff in its Hong Kong office, including ten investment professionals. “We believe Hong Kong is uniquely positioned as the offshore financial center for China and that this will support growth in the years to come,” says COO Taniguchi.
Naomi Denning, head of investment for Asia-Pacific at advisory firm Towers Watson & Co., echoes that view. “Hong Kong has become even more important today for global asset managers than in the past,” she says. “This is not only because China’s position in the global economy remains strong even after the global financial crisis. Given the fact that Hong Kong continues to be the international financial center of China and a center for trading goods and services, the financial linkages between both economies remain robust.”
Pyramis Global Advisors, the institutional investment arm of Fidelity Investments, has been staffing up in Hong Kong since opening a distribution office there in 2009. The firm, which manages $18 billion in the Asia-Pacific region, has 20 staff in the office, including its head of international sales for Asia and several members of its global investment research and securities trading teams. The office spearheads the firm’s effort to gain Asian clients, including sovereign wealth funds and pension funds.
“Our presence in Hong Kong provides a critical resource for decisions made by the firm in the Asia-Pacific region,” says Kevin Uebelein, president and chairman of Smithfield, Rhode Island–based Pyramis. “The entire region is experiencing strong growth.”
A strong rise in demand from investors in Hong Kong, mainland China and Taiwan has allowed Franklin Templeton Investments to grow the assets it manages from Hong Kong to more than $9 billion currently from just $150 million ten years ago, says David Chang, the firm’s regional head for Greater China.
“We are very optimistic about the growth of institutional business across the Greater China region and the insurance channel in Hong Kong,” he says. “If anything, the uncertainty in the U.S. and the European Union will see greater importance of our Asian operations, including in Hong Kong.”
The lure of China remains strong even though the mainland’s equity markets have performed poorly of late. China’s CSI 300 Index fell 16 percent in 2011, largely as a result of the government’s tighter monetary policies, designed to cool the economy and prevent a real estate bubble.
Most analysts believe those policies have worked effectively. The consensus view is that Beijing has managed to ward off speculative excess and slow the economy to a more sustainable rate without provoking a hard landing. Last month the authorities announced that the economy grew by 9.2 percent in 2011, down from a rate of 10.4 percent the previous year. Most economists believe growth will slow further this year but will still achieve a pace of at least 8 percent. That should create a positive environment for the stock market, many analysts believe.
“Chinese equities are attractive relative to history and are likely to be supported by monetary easing and supportive government policy,” says HSBC’s Munro.
Foreign investors have only a very small direct stake in the Chinese market. Since Beijing introduced the qualified foreign institutional investor scheme in 2002, allowing outsiders to invest directly in the A-share markets in Shanghai and Shenzhen, authorities have issued 135 licenses to foreign fund managers. Those managers currently have $21.6 billion in their QFII funds, representing less than 1 percent of China’s stock market capitalization. But in an apparent sign of loosening restrictions, the authorities in December granted 14 new QFII licenses, the same number that they had handed out in the previous 11 months.
The QFII program is only the tip of the iceberg. Investors are also gearing up for new ways to play the Chinese market by taking advantage of the gradual liberalization of the mainland currency, the renminbi.
China has taken a number of steps in recent years to increase the international use of the renminbi, whose unit is the yuan, and authorities have designated Hong Kong as the primary offshore center for the currency. Beijing’s policy initiative has fostered the introduction of a range of products, including renminbi-denominated bonds and funds, that asset managers are eager to exploit.
Consider the development of an offshore market for renminbi-denominated bonds, known as dim sum bonds. Beijing permitted multinational companies to make dim sum offerings in 2010, and issuance has grown rapidly, exceeding 100 billion yuan ($15.9 billion) last year, compared with 36 billion yuan in 2010.
AllianceBernstein, a New York–based manager with $406 billion in assets, including $214 billion in fixed income, last year launched RMB Income Plus Portfolio, a fund that helps investors gain exposure to dim sum bonds. The fund joins a series of other products in local currencies including the Hong Kong dollar, the Singapore dollar and the Australian dollar, says Brian Lo, a Hong Kong–based spokesman for the company.
The potential for more renminbi products appears to be strong. China has permitted investors to open renminbi bank accounts in Hong Kong since 2004, and the total volume of deposits more than doubled last year, to over 600 billion yuan, according to the Hong Kong Monetary Authority.
Liberalization is increasingly a two-way street. Recently, China has begun to allow its own financial services companies to expand their operations in Hong Kong and offer a wider range of products. So far, there are ten Chinese asset managers with operations in Hong Kong, and three more recently received regulatory approval from mainland authorities, says Anthony Skriba, an analyst with Z-Ben Advisors, a Shanghai-based consulting firm. Fifteen Chinese brokerages have set up subsidiaries in Hong Kong.
Mainland fund managers and brokerages are preparing to take advantage of a new program announced in a speech in Hong Kong last August by Vice Premier Li Keqiang, who is expected to succeed Wen Jiabao as China’s premier next year. The RMB qualified foreign institutional investor, or RQFII, program will allow Chinese fund managers to raise yuan from Hong Kong investors and put them to work in mainland markets. Until now the Hong Kong subsidiaries of mainland fund managers have been restricted to managing offshore products — mostly H shares, or Hong Kong–listed shares of mainland companies.
Guangzhou-based E Fund Management Co. — the fourth-largest Chinese fund manager, with more than $22 billion in assets last year, according to II’s China 20 (Institutional Investor, October 2011) — is among a batch of 21 mainland asset managers and brokerage houses approved by Chinese authorities to kick-start the program. Those firms have been granted quotas allowing them to raise as much as 20 billion yuan in Hong Kong.
This month E Fund will seek to raise 1.1 billion yuan from retail and institutional investors for its RQFII fund, says Charles Wang, CEO of E Fund Management (HK) Co. If successful, the fund will nearly double E Fund’s assets under management in Hong Kong, to something approaching $400 million — not bad, considering that the mainland asset manager set up shop in Hong Kong only in 2008.
“We see explosive growth in the coming few years,” Wang says. “Hong Kong is an axis of capital. Many global players want access to Chinese capital. Chinese financial players want access to global capital. Hong Kong offers a competitive platform for Chinese asset managers as well as global players.”
Financial Services Secretary Chan calls the new fund scheme a breakthrough that will broaden investment opportunities and boost offshore liquidity in renminbi-denominated stocks and bonds. “With the development of RMB asset classes offshore, offshore RMB liquidity need not go after investment opportunities in mainland China,” he says.
The offshore renminbi market looks set to heat up further. Last month officials from the China Securities Regulatory Commission announced at the Asian Financial Forum in Hong Kong that they will encourage Chinese companies to begin making renminbi-denominated IPOs in Hong Kong.
“The financial infrastructure in Hong Kong is ready for RMB-denominated listings,” Chan says. “I believe with this new policy directive from the CSRC we will see more RMB-denominated equity listings come to our market.”
Chinese authorities are granting other freedoms to mainland companies. They have issued licenses to 29 mainland brokerages and asset managers to establish qualified domestic institutional investor funds, which will allow them to raise capital from Chinese investors and place the funds in Hong Kong equities.
“Despite rapid development and improvement of onshore financial markets, many Chinese firms feel they are unable to gain global experience unless they head to Hong Kong,” says Z-Ben’s Skriba. “Hong Kong is also close enough to their comfort zone, at least in investment expertise, that it makes a natural first step.”
China’s internationalization of the renminbi will be a major driver of the growth of Hong Kong’s asset management industry, especially hedge funds, says Christophe Lee, chairman of the Hong Kong branch of the Alternative Investment Management Association.
Asian hedge funds have suffered big losses since the outbreak of the financial crisis, with overall assets declining to $145 billion by the middle of last year from $192 billion in 2007, according to industry tracker AsiaHedge. But there is increasing optimism in Hong Kong’s hedge fund circles.
“We see more hedge funds coming to Hong Kong,” says Lee. “Why? China. There is a very clear trend of internationalization of the RMB, and it is very clear that Hong Kong will be a major part of this process.”
Since becoming chairman of AIMA’s Hong Kong arm in 2004, Lee has seen corporate and executive membership grow from 21 to nearly 180 today — twice the number of AIMA members as in Singapore, Hong Kong’s rival hedge fund hub.
Demand is rising among global institutional investors for hedge fund exposure to equities in the Greater China region, say Robert Lance and Philip Tye, co-founders of Hong Kong–based DragonBack Capital, a firm that specializes in providing local hedge funds with a wide-ranging platform of services, including risk management and fund administration.
“Hong Kong has strengths as a global financial center with a strong regulatory environment, and it has proximity to China,” says Tye, who is also a member of AIMA’s London-based global council. “That makes it very, very appealing to fund managers and those in the alternative space.”
More than 70 percent of the 1,000-plus companies listed on the Hong Kong exchange are either based in China or do substantial business there. Crucially for hedge funds, most of those equities can be shorted.
Kenneth Stemme, head of research at Rye Brook, New York–based Larch Lane Advisors, which has seeded 26 hedge funds that collectively manage $3.7 billion, says he thinks Hong Kong is on its way up as a global hedge fund center.
“My first trip to Asia was 1997, and my CEO first came in 1990,” Stemme says. “Over the past 20 years, Tokyo was the first stop. Now it is not. Increasingly, Hong Kong is the first stop. For a while, there was a push and pull between Hong Kong and Singapore on where the talent is. Right now we see Hong Kong ascendance and Singapore losing some ground.” • •
