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After decades of lackluster and even declining performance, Japanese equities are seeing renewed interest from hedge funds across the world. As the Bank of Japan enters a new era of loose money policy, mostly implemented through quantitative easing similar to that being undertaken in the US, a declining Yen has the largely export-focused Japanese economy set for breakout growth. This has drawn the attention of hedge funds looking for opportunity to squeak out some incremental earnings for their portfolios in a very difficult global market.

After posting year-over-year declines in both 2010 and 2012, the benchmark Nikkei 225 Japanese equity index has a remarkable 2012 posting returns of nearly 23 percent. This has been followed by an explosive start to 2013, where returns have now exceeded 32 percent. Most of the growth has come from the optimism surrounding Japanese exporters who stand to benefit from the weakened Yen, which has fallen over 11 percent against the dollar in the first four months of the year.

Japanese Focused Funds Posting Strong Returns

Many hedge funds that focus on Japanese equities have dramatically outperformed their US, European or Asia (excl. Japan) peers. Sloan Robinson, a London-based fund, has posted a 44.6 percent return in its Japanese fund this year, while the Blue Sky Japan fund recorded a very impressive 36 percent gain. These two leaders are joined by the Martin Currie Japan fund which returned 19 percent so far this year, which also betters both the S&P 500 and the MSCI Europe Indices.

Even those outside of Japanese equities have been able to benefit from the new monetary policy adopted by the Bank of Japan. Currency focused funds have been able to profit immensely when shorting the Yen through the first third of 2013. Macro funds, who take positions in currencies in order to bet on their perceived outlooks for regional economies, are some of the biggest winners. Despite on average only earning 7 percent in the four years prior to 2013, macro funds such as Jones’ Tudor Investment Corporation and Caxton Associates have bettered that benchmark in the first four months of this year alone.

Economies with Aggressive Monetary Policy Become Attractive Investment Targets

As the global economy continues to sputter several years after the financial crisis, investors are actively seeking leadership from those at the reins of monetary policy in potential target investment countries. The strong performance coming out of Japan stands in stark contrast to Europe, where a disjointed and piecemeal approach to monetary and fiscal policy has left investors uncertain about the future. More so, quantitative easing has played a large part in the recovery in the United States, where the Dow Jones recorded an all-time high just last week briefly crossing the 15,000 level.

In an era where currency risk can be easily hedged away, funds currently have the leeway to take advantage of the positive impacts of loose monetary policy on equities. Funds that take advantage of these opportunities will almost certainly be leading the pack until a global recovery takes hold and the repercussions of these aggressive central bank decisions become known, for better or worse.

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Following a global trend in hedge fund investing by large pension funds, Japan’s Teachers’ Mutual Aid Co-operative Society will begin exploring hedge funds as a potential investment to diversify risks and increase returns for the fund. According to Bloomberg, the 600 billion yen fund it looking to allocate approximately 100 billion yen of its capital into alternative investments including foreign stocks, bonds, REITs and hedge funds before the end of its 2013 fiscal year. Hedge funds will see approximately 12 billion yen in new investments.

Japanese Funds Following a Global Trend in Hedge Fund Investing

Japan is not the first country to see major pension plans undertake investment in hedge funds. The Globe and Mail reported earlier in September that Canadian pension plans were also looking at the funds to diversify risk in a challenging interest rate environment. Hedge funds are providing the alternative returns, delinked from equity indexes, which many portfolio managers are seeking.

Lower Interest Rates Driving the Switch to Hedge Funds

Portfolio managers for major pension funds or other portfolios with long lived liabilities are always looking for assets without correlation to major stock indices. In the past, this was easily accomplished without much expense by investing in fixed income products. However, as interest rates are currently at historical lows across the curve, portfolio managers need to get creative in how they diversify their portfolio. Long bonds carry significant risk today, and short bonds don’t pay enough for funds to meet certain investment hurdles.

As a result, more funds are considering investing in hedge funds as an alternative. Whether these are market neutral funds, commodity linked funds or funds that employ other strategies, they often offer returns that are not strongly linked to large equity markets. This allows the portfolio manager to see higher returns, while still accomplishing the objective of diversifying away equity risk.

Returns in Asia Falling Short of Expectations

While economic growth in Asia has continued to be strong through the eight months of 2012, the growth isn’t translating into gains for Asian hedge funds. The Eurekahedge Asian Index returned only 1.6 percent to the end of August, which was half of the global benchmark return. This return also trails the 8.2 percent climb in the MSCI Asia Pacific Index, a broad basket of Asian equity indexes across several countries.

However, hedge funds are not meant to track indexes, which is why many funds are considering the asset class for investment. In the truest definition of a hedge fund, it would like underperform the index during bull times and over perform the index during bear markets. While the Japanese pension funds exploring hedge funds should certainly consider better performing global hedge funds, alternatives do exist in Asia that would meet their requirement for diversification away from equities, and also provide more return than fixed income assets.

What does this mean for Job Seekers?

The hedge fund industry certainly has shown some signs of growth over the past few quarters, though the growth has been sporadic and interwoven with cuts in other firms. Competition for new positions remains fierce and those applying should have significant experience in the hedge fund industry or in a related target investment industry. If fixed income returns remain low for an extended period of time, however, more opportunities could become available as portfolio managers look at add return that is not linked to equity markets to their funds.

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