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Credit Markets in China and India Are Focus For Asian Hedge Funds (November 8, 2007)

Location: New York
Author: Alex Paidas
Date: Thursday, November 8, 2007

The rapid growth of hedge funds in emerging Asia was underscored by their increased activity in the highly volatile and opportunistic credit markets of China and India, according to a study releasedÿyesterday by the financial services industry consultancy Oliver Wyman. Nearly 80 percentÿof the largest Asia-focused hedge funds are investing in China and India's credit markets, reflecting the growing importance of the Asia Pacific region to the $2.5 trillion hedge fund industry worldwide.

The study, which gauged the market and product preferences of Asia-focused hedge funds active in credit markets, revealed that trading in certain products is limited by low liquidity, but that fund managers expect a steady maturation of the credit market throughout the region. The investment preferences of 60 of the largest Asia-focused hedge funds were examined for the study.

The study also shows that, in addition to trading a range of credit products, Asia-focused hedge funds are investing heavily in special situations and private placement deals, indicating growing confidence in the financial prospects of an array of the region's emerging corporations.

"A favorable environment for hedge funds continues to develop in Asia," said Bradley Ziff, director of the hedge funds advisory practice at Oliver Wyman. "Not only are there more than 600 funds domiciled in Asia, but hedge funds have become an important part of the capital equation that is central to the growth of Asian economies."

Five of the top 10 most-attractive Asian markets for credit-focused hedge funds are developing countries. After China and India, the most attractive emerging credit markets for hedge funds are Philippines, Thailand and Indonesia. The growth prospects for infrastructure, utilities, and commodities companies are fueling hedge fund trading of credit products in these countries.

Credit Market Activity for Asia's Hedge Funds

1. China 78% 6.ÿ Philippines 44%
2. India 76% 7.ÿ Australia 39%
3. Japan 71% 8.ÿ Thailand 33%
4. Taiwan 59% 9.ÿ Indonesia 30%
5. Korea 45% 10. Hong Kong 29%

"What's novel is that, despite the region's heavy reliance on developing economies, a growing amount of capital is focused on credit markets in Asia," said Bradley Ziff of Oliver Wyman. "Hedge funds and dealers recognize that, in the coming years, credit products in emerging Asia will present some of the most profitable opportunities for trading and managing risk."

Seventy-five percent of the hedge funds studied consider special situation deals in Asia "important" to their business. Of those, about half consider special situations "very important."

Seventy-nine percentÿof the hedge funds studied are active in privately-placed high-yield debt deals in Asia. Acknowledging limited liquidity for these investments, funds prefer to limit tenure to between two and five years.

According to the study, Indonesia, with its wealth of natural resources, is among the most important countries for hedge funds seeking special situations and private placements.

"The significant activity in private deals in Asia illustrates hedge funds' willingness to invest directly in promising, asset- and resource-intensive companies that are central to the development trends of the region," noted Ziff, author of the study at Oliver Wyman.

According to the study, corporate bonds are the most actively traded product (86 percentÿof funds).ÿSeventy-seven percentÿof funds are active in trading credit default swaps, 46 percentÿare trading convertible bonds and 32 percentÿare trading bank loans.

As a group, the hedge funds studied invest equally in high-yield and investment grade credit products. 45 percentÿof the funds have a preference for high-yield and 41 percentÿfocus on investment grade.

Thirty-six percentÿof funds say they trade local indices and that number is expected to rise as the indices become more representative of local economic trends.

Fund managers cited limited liquidity as a constraint to business, particularly in single-name credit default swaps, in certain regions. However, managers predict credit spreads in Asia will continue to widen, creating an increase in trading volume as volatility rises.

Already, about a quarter of funds in Asia invest in structured credit products. Several participants expected their investment in structured credit to increase significantly.

"The interest in a spectrum of credit products by Asia's hedge funds is leading the region's credit markets to develop in a unique way. Current levels of support for the issue of new debt and loans in Asia indicates to us that there soon will be enough underlying collateral in circulation for the formation of structured credit products, " observed Ziff.

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