Mamoru Taniya was never meant for the predictable life of a Japanese salaryman. As a Tokyo University graduate with a BA in law in 1987, he stunned family and friends by turning down job offers from major Japanese corporations in favor of a seat on Salomon Brothers’ Tokyo trading desk. Twenty years later, Taniya is taking an even bigger risk: He is running a hedge fund firm in the country widely acknowledged as the least hospitable to such investment vehicles.
Taniya, 44, is co-founder and CEO of Asuka Asset Management, Japan’s second-largest hedge fund firm, which started the fourth quarter of 2007 with $1.65 billion in overall assets under management and $859.7 million in hedge fund assets. That’s not a misprint — the second-biggest hedge fund firm in Japan has less than $1 billion in hedge fund assets. Although Japan has the world’s second-largest economy, its domestic hedge fund industry had only $8.5 billion in assets at the end of September, according to Singapore-based research firm Eurekahedge. Even taking into account Japan-focused hedge funds based in other countries, overall hedge fund assets at work in Japan totaled only $32 billion at the end of the third quarter of 2007. Asia’s largest hedge fund company, Sparx Asset Management Co., had about $9.2 billion in Japan-focused assets at the end of October, about half of which were in hedge funds. Globally — to put these numbers in context — the world’s 100 biggest hedge fund firms managed a combined $1 trillion when 2007 began, according to Alpha’s 2007 Hedge Fund 100.
It is into this stunted market that Taniya and his partners have ventured with Asuka. Their struggles over the past five years illustrate the persistence and creativity needed to operate a hedge fund in Japan. Managers of Japan-based hedge funds must cope with operating costs that are among the highest in the world, a risk-averse high-net-worth segment and an institutional bias toward brand-name asset managers with foreign addresses. To survive, Asuka has traded on its own pedigree as the offshoot of a major U.S. firm and diversified its business through joint ventures that veer far afield from traditional hedge fund structures.
In many ways Asuka’s diversification strategy is what keeps the firm afloat, as Japan’s fledgling hedge fund industry finds itself in the midst of a punishing market downturn that has reduced total industry assets by 46 percent since the end of 2005, according to an analysis conducted by Tokyo-based fund-of-hedge funds manager Rogers Investment Advisors. “It’s almost a perfect storm of negative factors,” says the firm’s founder and CEO, Edward Rogers.
Taniya started Asuka in 2002 with two longtime colleagues, Toshihiro Hirao, chief investment officer, and Kazuho Toyoda, director of risk and research. All three worked at Salomon Brothers in the late 1980s and moved to Tudor Capital Japan’s Tokyo office in 1999. Things changed dramatically for them in 2002, when Tudor announced it was shelving its plan to run a fund based in Japan and shifting Japanese investment operations back to the U.S. Based on their experience and success, the three friends could have taken jobs at large Tokyo financial institutions. But for Taniya, the riskier option was more compelling: He orchestrated a buyout of Tudor’s Japanese business and launched his new hedge fund company into a market so inhospitable to investment management newcomers that even hedge fund giants like Tudor opted to operate offshore.
Domestic hedge funds are a hard sell in Japan. Japanese high-net-worth investors are rarely tempted by hedge fund investments of any kind, preferring instead to stash assets in low-yielding bank accounts, government bonds and real estate. Institutional investors tend to favor large global brand names when selecting hedge funds. Often, Japanese institutions seek out hedge funds operating in New York or London expressly for foreign market exposure to diversify portfolios already heavily weighted to domestic equities. Cultural norms and perceived career risk also contribute to institutions’ bias for well-established foreign hedge funds, says James Fiorillo, founder of Tokyo-based investment advisory firm Ottoman Capital. “It’s a place where the locals have to be very careful about saving face and reputation.”
Japanese institutions have every reason to be wary. The Japanese hedge fund industry got off to a late start because of the 14-year bear market in Japan, from 1991 to 2004, and many of the funds that have braved this difficult environment have failed to perform up to expectations. In recent years the runaway economic growth and strong investment returns in China and India have overshadowed new opportunities arising from Japan’s economic recovery.
“Investors are frustrated,” says Rogers. “They believe that actual hedged funds are hard to come by here and see that the long-short space is highly correlated to the long-only index space. Investors aren’t willing to pay 2 and 20 for that — nor should they.”
Without a doubt, the single biggest impediment to the growth of the Japanese hedge fund industry has been the nation’s regulators, who are almost overtly hostile to start-up funds. As a result, most managers operate Japan-focused funds out of Hong Kong, London, New York and Singapore.
“The regulators appear not to want the industry to grow much,” says Peter Douglas, founder and principal of GFIA, a Singapore-based research and consulting firm specializing in Asian and Latin American hedge funds. “It’s very difficult to start any kind of entrepreneurial or boutique money management business in Japan.”
It can take years for an aspiring entrepreneur to obtain the discretionary fund management license required to sell products directly to Japanese investors. “It’s very hard to be authorized,” says Tetsuya Abe, head of compliance at investment management firm Epic Partners Investments Co. “There are many strict regulations.” Epic received its discretionary license in May 2006 after an eight-month application process. Abe says not a single asset management firm was awarded a license in the three years before his firm’s success, and he knows of at least ten applicants still stuck in the queue.
Abe offers an alternate, simpler, explanation for why Japan has failed to develop a vibrant hedge fund community: Few Japanese professionals have any desire to strike out on their own. “Most Japanese want to be salarymen,” he says.
Taniya and his colleagues are not like most Japanese. The firm they launched now employs 27 professionals, including ten fund managers, and runs three of Japan’s most established hedge funds: the $210 million Asuka Japanese Equity Long Short Fund, the $312 million multistrategy Asuka Opportunities Fund and the $337 million Value Up Fund. (All asset figures are as of September 2007.)
Although the three hedge funds have outperformed their benchmarks since inception, the hard realities of the Japanese market have caught up with Asuka. Like the rest of the Japanese hedge fund industry, the firm has taken body blows from a dramatic downturn that began about 18 months ago. Asuka’s hedge fund assets under management declined more than 25 percent in the first nine months of 2007 from a high of $1.2 billion at the end of 2006, despite relatively strong performance.
A broad retreat by Japanese investors is being driven by concerns about the near-term market direction — the benchmark Topix index was down more than 8 percent for the first 11 months of 2007. Rather than waiting to see whether the Japanese market would hold up, many investors shifted funds to faster-growing countries like China, where the benchmark CSI 300 index was up more than 137 percent for the year through November. As part of the contraction, domestic hedge fund assets in Japan declined to the $8.5 billion at the end of September from $11 billion when 2007 began, according to Eurekahedge. Japan-focused hedge fund assets around the world plummeted, from $65 billion at the end of 2005 to less than $35 billion, says Rogers. “It was nothing short of a catastrophe for managers,” he adds.
Eurekahedge notes that at least 31 of the roughly 250 Japan-focused hedge funds operating around the world were forced to close in 2006, and more hit the wall in 2007. Many funds were blindsided in 2006 by the meltdown in Japan’s small- and midcap equity sector. This implosion was triggered by the January 16, 2006, arrest of Takafumi Horie, then-CEO of Internet market darling Livedoor Co. His arrest set off a 12 percent single-day slide in the Mothers small-cap index. Horie was subsequently convicted of falsifying earnings and sentenced to 30 months in prison. When Yoshiaki Murakami, the corporate raider who was the most prominent agitator for corporate governance reform in Japan, was charged with insider trading in June 2006, sentiment further soured. Murakami was sentenced in July 2007 to two years in prison.
Horie’s arrest began what proved to be the worst month in Asuka’s history — a performance from which the firm was not able to recover in 2006. Asuka’s long-short fund slumped 4.8 percent in February of that year compared with a 2.18 percent decline in the Eurekahedge long-short equities hedge fund index. For the full year the fund was down 7.1 percent, compared with a fall of 3.57 percent in the index, its worst-ever annual performance. Though the Opportunities and Value Up funds also fell that year, they both outperformed their benchmarks. The former was down 1.63 percent against a 6.33 percent decline on Eureka’s benchmark index, while the latter slumped 8.79 percent, still far better than the 56 percent drop on the small-cap Mothers index.
Asuka CIO Hirao describes 2006 as the toughest year of a career that began in 1987 at Salomon Brothers, where he served as co-head of proprietary trading with Taniya and also managed an ¥80 billion ($523 million) convertible bond and warrant arbitrage portfolio, as well as Salomon’s long-short equity positions. Hirao says that before 2006, it had been 17 years since he had lost money on an annual basis. “Day by day, the main market drivers of stocks were changing,” he explains. “It was a tough year to manage a portfolio.”
Nevertheless, Asuka weathered 2006 better than most competitors. The firm’s assets under management actually increased 37.6 percent, despite what Rogers estimates was a net outflow of $15 billion from the Japanese hedge fund industry as a whole, including both domestic and offshore funds. Asuka’s ability to continue attracting capital while the rest of the industry was hemorrhaging assets can be attributed to two factors: its association with Tudor, which still owns 3 percent, and an early decision by Taniya to expand the firm beyond traditional hedge funds.
Taniya was hired by Tudor in 1999, initially to run its Tokyo-based Japanese fixed-income arbitrage operation. After the Bank of Japan decimated the arbitrage business that year by slashing short-term interest rates to near zero, Taniya instead helped Tudor launch a Japanese private equity business that generated a 40 percent annualized internal rate of return from 1999 through 2002. Hirao and Toyoda also joined Tudor in 1999. Hirao managed a $200 million Japanese equity long-short portfolio; Toyoda headed Japanese company research.
Asuka’s Tudor origins bestow a degree of brand-name credibility in both high-net-worth and institutional circles. “Many funds ask Paul about us, and we are fortunate he could give us a good reference,” says Taniya, referring to Tudor founder Paul Tudor Jones II. “Tudor introduced many investors to us.”
Hirao says he and Asuka’s co-founders have tried to re-create the Tudor work environment, which he describes as a “paradise,” with “no politics, hierarchy or bureaucracy.” Asuka looks to replicate that flat organizational structure by giving its managers a high degree of freedom within set parameters — a commitment that the founders think helps attract and retain Japan’s top investment managers. “In most hedge funds, when the owner is a very good manager, he tends to control things,” says Taniya. “Paul was so warmhearted and so generous, he let other people take risk.”
The firm inherited one additional characteristic from Tudor that has helped it market itself to relatively conservative Japanese investors: an unswerving dedication to capital preservation. “Even when they thought they were doing the right thing, if the market was against them, they left the market,” Taniya says, referring to Tudor’s insistence on stop-losses. Asuka’s funds have strict stop-loss limits of 2 percent of net asset value. Only the Value Up Fund can take single positions that are larger than 5 percent of net asset value.
The other critical component of Asuka’s strategy is avoiding event risk. “Not being killed is the most important thing,” Taniya says. “It is difficult to find good opportunities, even for good fund managers. As long as we survive, we can recruit the best investment talent, and that talent can find good opportunities.”
This philosophy appeals to Japanese institutional investors, for whom the promise of high-single-digit annual returns can be attractive, says GFIA’s Douglas. This type of return, hedged into Japanese yen, is quite valuable in a market where many institutions have long-term liabilities of 2 to 3 percent and domestic bond yields are less than 1 percent.
Even with the benefits of the Tudor imprimatur and organizational model, however, Asuka’s survival was hardly assured. In fact, the primary reason that the firm has been able to maintain its growth is that it has diversified its business with joint ventures in funds of funds, commodities hedge funds and discretionary investing for stand-alone clients such as the Development Bank of Japan. This diversification strategy has been responsible for most of Asuka’s asset growth since the end of 2005.
Asuka operates three joint ventures and one discretionary management account that total $792 million. In late 2004, Asuka partnered with Monex Beans Holdings, Japan’s second-largest online broker, to found Monex Alternative Investments, which manages $250 million in funds of funds. MBH was a logical partner, as its CEO, Oki Matsumoto, and Taniya have been close friends since they started work at Salomon Brothers on the same day in 1987. Both men believe that Japanese retail investors, who have more than $13 trillion in household assets, badly need alternative investment options. Matsumoto suggested the two firms join forces: He wanted better products to offer to MBH’s online retail brokerage clients, and Asuka, which owns 49 percent of the joint venture, had the connections in the hedge fund and private equity worlds to help source them.
MAI’s first product was the Monex Capital Partners Fund, which was launched in July 2005 and now has $20 million in assets. The fund can invest in hedge funds, private equity funds, managed futures funds and real estate investment trust funds. The company’s second fund, the Fullerton-Monex Asia Fund, is jointly managed with Singapore’s Fullerton Fund Management Co., a subsidiary of giant state-owned Temasek Holdings. Also launched in 2005, the fund divides its investments between hedge funds in Japan and those in the rest of Asia, which are managed by MAI and Fullerton, respectively. It has assets of $130 million in 30 hedge funds, 14 focused on Japan and 16 on the rest of Asia.
MAI’s third fund, launched in August 2006, is the Premium Hybrid 2006 fund, which invests 70 percent of its $43 million of assets in private equity funds and 30 percent in hedge funds. It is the first such fund marketed to Japanese retail investors, who can gain access to private equity funds run by titans such as Carlyle Group and J.C. Flowers & Co. for a minimum investment of just ¥500,000. “In the rest of the world, small investors would give their right arm to buy a fund like this,” says Matsumoto.
Monex Beans also distributes a fourth MAI fund, managed by Fullerton. The Fullerton China-Focused Fund was launched in August 2006 and invests in China A-shares. The long-biased fund has $60 million in assets and uses futures to hedge its exposure. MAI is considering launching additional funds in the areas of commodities futures, green technology and real estate.
MAI has applied for a discretionary investment management license, which would enable it to begin marketing directly to Japanese institutional investors, especially pension funds that now invest mainly in foreign-based funds of funds. Matsumoto believes MAI’s assets have the potential to quickly reach $1 billion and that even $3 billion is a realistic target. “We think there is a huge opportunity,” he says.
In spring 2005, Asuka began managing a $100 million discretionary fund for entertainment company Yoshimoto Kogyo Co., which employs the majority of Japan’s comedians. Asuka followed up in 2006 by joining forces with Japanese trading giant Mitsui & Co. to form Mitsui & Co. Asuka Investments. The joint venture’s flagship offering is MA Opportunities, a multistrategy commodities hedge fund with $42 million in assets. (Asuka owns 37.5 percent of the venture.) Mitsui & Co. Asuka chief executive Shoichiro Ishibashi describes MA Opportunities as the first multistrategy commodities hedge fund in Japan, and its managers have set a target of $300 million in assets for 2011. The fund had a difficult first year, however, ending 2006 down 2.79 percent in a relatively strong market for commodities. It reached positive territory in 2007, with a 1.41 percent return through September.
Asuka’s partner in Asuka DBJ Investment is government-owned Development Bank of Japan. Asuka DBJ Investment was founded in October 2005 with $400 million in assets under management, according to industry sources. The firm owns a 45 percent stake in a venture with Boston-based Gordon Brothers Japan, which is the first company in Japan to provide inventory liquidation services for troubled and bankrupt retailers.
In each of these joint ventures, Taniya says Asuka sought out businesses in which competition is at a minimal and growth potential is large. The same philosophy can be seen in his decision to enter the Japanese hedge fund industry. “It may look like we are investing in many different businesses, but the essence is the same,” says Taniya. “We try to find good investment opportunities in less-competitive areas.”
Taniya strongly emphasizes that hedge funds remain Asuka’s core business. Despite the difficulties of operating in Japan and the battering taken by the country’s hedge fund industry, he is upbeat about future prospects. Taniya believes the ongoing sell-off in small- and midcap stocks has created opportunities for value investors. In 2006, Asuka closed its Long Short and Value Up funds to new investors, but depressed valuations have brought a change in strategy, and the funds are again open to investors. “We believe the Japanese market has become cheap again, so we want to raise money for everything,” Taniya says.
Still, Taniya is realistic about the limitations of the alternative asset industry in Japan and realizes that the only way to ensure growth as a relatively new manager is to offer a diverse product slate. “Nobody knows when growth is coming,” he says. “When the wind does come, we want a big sail. That’s our strategy.”
