Japan’s hedge funds sparkle with ‘hidden jewels’

by Tomoko Yamazaki and Komaki Ito

Bloomberg

Hideki Wakabayashi sat through 500 meetings with company executives before settling on the stocks that produced a 13 percent advance last year for the long-short equity hedge fund he runs at Tokyo-based Finnowave Investments.

Toru Hashizume matched Wakabayashi’s performance with a 13 percent return for his Ginga Service Sector Fund by following a similar path. He said he sifted through 800 stocks before betting on about 70.

The Japanese hedge fund managers plan to beat benchmarks again in 2009 by shunning computer-driven trading in favor of company research. Their gains contrast with the average 19 percent drop of global hedge funds, according to data compiled by Chicago-based Hedge Fund Research Inc., and the 42 percent slump in the Nikkei 225 stock average during 2008, the index’s worst annual performance.

“When everything is sold right down and individual companies are in make-or-break mode, it is likely to be more of a stock-picking environment,” said Peter Douglas, principal of GFIA Pte, a Singapore-based hedge-fund consulting firm. “The hidden jewels of Japanese hedge funds will have a good year.”

The ¥10 billion Finnowave fund has extended its gains this year, returning 1.6 percent in January and 1.3 percent in February, compared with a 0.3 percent increase and 0.7 percent decline, respectively, by the Eurekahedge Hedge Fund Index tracking more than 2,000 funds.

Hashizume at Tokyo-based Stats Investment Management Co., which looks after ¥7.2 billion and advises the Ginga fund, has limited declines at his telecommunications and services-focused fund to about 2 percent this year, while indexes tracking those industries in Japan slumped 21 percent and 14 percent, respectively.

About 90 percent of the more than 200 hedge funds that focus on Japan are research driven, shunning the model trading strategies that account for almost half of the global industry, according to data from Eurekahedge PTE and Hedge Fund Research. About 40 percent of funds that focus on Japan posted positive returns in 2008, compared with 27 percent in Europe and 38 percent in North America, Eurekahedge reported.

Japan’s independent hedge funds, those not affiliated with a financial institution, hold a fraction of the assets relative to global firms like Kenneth Griffin’s Citadel Investment Group LLC, which has $13 billion. They account for 95 percent of Japan-focused hedge funds and manage a total of $12.1 billion in assets, according to Singapore-based Eurekahedge.

“Japan-focused hedge funds are making money,” said Ed Rogers, chief executive officer of Rogers Investment Advisors Y.K. in Tokyo, whose $15 million Japan-focused fund of hedge funds, Wolver Hill Japan Multi-Strategy Fund, returned 6 percent in 2008. “The numbers just don’t lie.”

Finnowave mainly invests in stocks with a market value of at least ¥50 billion. The firm profited in 2008 by betting that shares of electronics stocks and export-driven companies would fall, and by acquiring shares of companies that include Nohmi Bosai Ltd., which benefit from an increase in domestic demand. Wakabayashi covered the electronics industry as an analyst at Nomura Holdings Inc.

Finnowave bought shares of Nohmi Bosai, a Tokyo-based maker of fire alarms and extinguishers, for about ¥600 each and sold them for more than twice that toward the end of the year.

Among other stocks that contributed to last year’s gain was Yokogawa Bridge Holdings Corp., a Tokyo-based bridge and steel tower builder. The fund invested in the shares on expectations that recent bridge collapses worldwide may boost demand for Japanese bridge builders that have among the best technologies in the world, Wakabayashi said.

In 2007, a Minnesota highway bridge collapsed, marking the worst such accident in 25 years, while in central China’s Hunan Province a bridge collapse left more than 30 people dead.

Wakabayashi has switched gears and said he is investing now in export-driven stocks and selling domestic-demand shares, on the view that much of the negative news has been priced into shares of many exporters. He declined to name specific stocks.

He said he is also focusing on firms that may benefit from increased awareness of energy saving and environment-related issues, such as Sumitomo Electric Industries Ltd.

“The funds that are going to survive will be those that are doing the legwork and researching their companies — craftsmanlike funds,” Wakabayashi said.

Epic Partners Investments Co.’s Prowess of Japan Fund, a so-called market-neutral fund that favors stock picking, returned 17 percent in 2008 and extended its gain to more than 4 percent this year. A weakness of many computer-driven models is rigid stop-loss selling, said Tetsuya Abe, head of compliance at Epic, with ¥36 billion in total assets. A stop-loss order triggers the sale of a security when it falls to a certain price.

“In an environment where we had the market going up and down by more than 10 percent on a daily basis, you start to see irrational pricing on stocks,” said Tokyo-based Abe. “We don’t abide by the stop-loss rule, so our managers held some valuable investments.”

GFIA’s Douglas said Japan’s so-called lost decade in the 1990s, when asset prices declined and bank bailouts hobbled the economy, prepared Japanese hedge fund managers better than their overseas rivals to navigate challenging investment times.

The Nikkei 225 fell 60 percent during the past 15 years, while the Dow Jones Industrial Average in the U.S. rose more than 90 percent.

Douglas’s firm made an average 2.3 percent from its Japanese hedge fund holdings in 2008, while the MSCI World Index of 1,678 companies plunged 42 percent.