At a time when a number of Asian institutions are just getting comfortable with moving from core to value add exposure as a "safer" way to access the US market at this late stage of the cycle, the rising currency hedging cost of these investments is presenting a roadblock. For Japanese and Korean institutions, the FX hedge back into their home currencies amounts to approximately 3% and 2% per annum respectively. When coupled with tax leakage and capital reserve costs faced by some investors, a low teens net return on a US value add fund, can potentially shrink to a high single digit return.
It is not really surprising then to see Korean institutions pivoting to European investments (where the FX hedge actually generates a small gain), along with debt strategies, and selectively intra-Asia opportunities. Japanese institutions, who are at a much earlier stage of building their US portfolios seem to be staying the course for now given lower hurdle rates. Their predominant focus remains US core open-ended funds, with only a handful of institutions looking at closed-end value add funds. However, it is clear from our recent discussions over new US opportunities that the hedging environment is top of mind and definitely giving Japanese investors some pause. This could slow down the anticipated pace of outbound institutional capital deployment that many were expecting to see rise this fiscal year.
Curiously, large Korean institutions have started to explore value add opportunities in their own market as evidenced by RFP's issued by NPS and Korea Post for value add domestic mandates in the past few months. These institutions have until now only given out core/core plus domestic mandates. We expect more may come from other institutions in Korea as moving up the risk curve in their own market appears to be a more logical step at the present time than trying to seek diversification abroad.
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