Japanese Hedge Funds 2024 Review and 2025 Outlook

Performance in the Japanese hedge fund industry in 2024 was driven by a combination of macro factors, ongoing excitement about Japanese corporate governance improvements and a resurgence of fundamentals.

Though, on the face of it, Japanese hedge funds (measured by the returns of the Eurekahedge Japan Long Short Index) did not manage to keep up with long only returns, delivering 10% versus 17.7% for the TOPIX index, Japanese hedge funds did once again show their resilience.

2024 highlights the severe shortcomings of indices purporting to provide investors with an accurate view of the performance of Japanese hedge funds. While a comparison of index returns to long only indices would lead one to believe that hedge funds underperform as a group, a more nuanced look, including funds in our proprietary database, tell a somewhat different story, with quite a few funds having significantly outperformed the TOPIX index. August, in particular, stands out as a case in point, where markets convulsed on the back of an increase in Japanese interest rates.

At its trough, the TOPIX index had lost -5.8%, whereas most hedge funds in the Japanese market lost a mere fraction of this, with some being positive. The Eurekahedge Japan Long Short Index, for example, ended the month down -0.88% whereas the TOPIX lost -2.92%. Overall, many hedge funds ended August with gains, by correctly reading market technicals and understanding that this was a buying opportunity rather than cause for panic. Japanese managers once again demonstrated that during bouts of extreme volatility, which are not uncommon in Japan, their robust risk management processes proved to be a superior way to allocate to Japan versus long only.

This once again highlights the difficulties faced by allocators in trying to accurately gauge the performance of what remains a very opaque part of the global hedge fund industry, where local knowledge and a deep network is required to get access to accurate return figures. Sadly, this means that investors may miss out on outsized returns as they simply do not have access to accurate information which would allow them to make informed investment decisions.

2024 felt more conducive to active management, though Japanese managers, as measured by the Eurekahedge Japan Long Short Index did not beat their North American peers, as they did last year. November, in particular, was an exceptionally strong month for Japanese hedge funds, with some generating very high single digit returns for the month on the back of the US elections. Though December saw some reversal, managers largely managed to hold on too most of the gains they had generated in the prior month. Q4 also allowed managers to recapture losses they endured during the August bout of volatility.

Dispersion between managers and strategies continued, as in prior years. Managers with flexible net exposure, that at times were able to have a long bias, managed to not only capture well-timed market beta but in some cases significantly outperform the TOPIX index. There were quite a few managers that generated returns in the twenties - and some even in the thirties - further illustrating that the Eurekahedge Japan Long Short Index returns tells only part of the story.

Manager selection, as is often the case, remained key. Top performing strategies included flexible net managers, as well as quantamental funds. Managers that were able to engage in ’soft activism‘ or that read corporate reform intentions of companies correctly (whether these were beneficial or damaging to shareholders) benefited handsomely. The fact that many low net managers also managed to generate double digit returns is further evidence that fundamentals had a more pronounced impact on returns in 2024 than in prior years. It was not too much of a challenge (especially in USD) to generate at least 10% from Japanese hedge funds in the past year. In last year’s report we noted that “Longer term structural changes in Japan, such as the improved treatment of shareholders, the restructuring of the Tokyo Stock Exchange and pressure being put on companies to increase dividends, are all tailwinds that should remain with the industry for years to come. Some managers feel this will provide an opportunity for the next 10 years, and though on the face of it this may seem like an argument for a long only approach to Japan, this should also provide plenty of short opportunities for managers.”

This remained true in 2024 and managers expect this to continue for years to come, being cited by many as one of the most exciting opportunities of their careers and a strong alpha driver going forward.

International allocator interest in Japan also continued apace, and the trend toward SMAs remained unabated. The struggle many international allocators face in terms of how-to best approach Japan has, however, not yet fully played itself out. Activist managers, which are, by and large long only, continue to benefit from this as they can absorb large institutional allocations which many local hedge funds cannot. However, months such as August are a case in point that just being long Japanese beta may not be the best way to engage with this market. Not every allocator is able to look through such periods and stay the course and often this means allocations are reduced or liquidated at the worst possible time.

Figure 1: Cumulative Returns, Equity vs Hedge Funds, through December 2024

Source: Eurekahedge, MSCI

Despite the ongoing rally in Japan, Japanese hedge funds as a group continue to significantly outperform the TOPIX index over the long term. Their strong risk adjusted performance also continued (see Figure 2 below). As a reminder, while the TOPIX index suffered a maximum drawdown of -53% and the NIKKEI 225 index a maximum drawdown of -51.7%, since the end of December 2007, the Eurekahedge Japan Long Short index only lost -12.3% over the same period, and with considerably less volatility at that (5.6% for Japanese hedge funds, versus 17.2% and 18.9% for the TOPIX and the NIKKEI 225 indices respectively). It remains clear, therefore, that Japanese hedge funds provide a superior risk-adjusted approach to investing in Japan.

Figure 2: Historical Cumulative Performance of Equity Hedge Funds Relative to Equity

(December 2007 - December 2024)

Source: Eurekahedge, Bloomberg

Perhaps one of the starkest ways to illustrate the value provided by Japanese hedge funds is the significant gap between the cumulative outperformance versus equities of Japanese Hedge funds and their North American peers in Figure 3 below, which became even more extreme in 2024 (as a side note, for the first time, European hedge funds have outperformed Japanese funds on this metric. Time will tell, however, whether that trend will continue). This is perhaps not unsurprising given the very narrow breadth of the rally in US markets, and the challenges this posed for long/short equity managers. It does, however, highlight once again that selecting the markets in which to allocate to hedge funds makes a significant difference in terms of value-add. Japan continues to be the standout in that regard, with the long-term gap between Japanese hedge funds and North American peers persisting.

Figure 3: Historical Alpha of Japanese Hedge Funds vs. North American, European Hedge Funds

(December 2007 – December 2024)

Data: North American equities = Eurekahedge North American Hedge Fund Index vs. MSCI North America Index (USD), European equities = Eurekahedge European Hedge Fund Index vs. MSCI Europe Index (EUR), Japanese equities = Eurekahedge Japan Hedge Fund Index vs. MSCI Japan Index (JPY).
Source: Eurekahedge, MSCI

2024 also saw the launch of several new managers in Japan, speaking further to the fact that investors and managers alike are starting to realize the potential offered by Japanese hedge funds.

Large global platforms also continued to actively recruit portfolio managers to trade Japanese equity markets. With a more normalized interest rate environment, strategies other than long/short are also starting to become viable again for the first time in a long time. While the Japanese hedge fund space is still very equity dominated, the expectation is that non-equity strategies will start to become interesting diversifiers and alpha opportunities in heretofore unexploited niches of the Japanese markets.

These developments diversify the tool set available to allocators and allows for the construction of even more robust portfolios of Japanese hedge fund alpha.

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Patrick Ghali is Managing Partner of Sussex Partners

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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group