Kazuhiko Asakawa, March 27, 2012 before the Congress (Source: Reuters)
In February 2012, Japan’s Financial Service Agency suspended the investment advisor license of AIJ, a little known Japanese hedge fund manager founded in 2000 by a former Nomura salesman. The public later learned that nearly 90% of $2.4 billion managed by AIJ was gone due to trading losses. AIJ’s investors, mostly small and medium corporate pension funds, were blind sighted. How was it possible to hide such massive losses for over 10 years?
|Fund Name||AIM Global Fund
AIM Millennium Fund
|Investment Manager||AIJ Investment Advisors Co.|
|Portfolio Manager||Kazuhiko Asakawa
|Other Notable Parties||AIA
ITM Securities Co., Ltd.
|Investment Strategy||Various option-related strategies|
|Estimated AUM||$2.4 billion|
|Estimated Losses||$1.3 billion|
|Fraud Causal Factors||- Theft and Misappropriation
- Misvaluation of Fund Assets
- Concealment of Trading Losses
- Fictitious Service Providers
- Conflict of Interest
- Strategy Misrepresentation
- Legal / Regulatory Violation
- Marketing Misrepresentation
Mr. Kazuhiko Asakawa (“Asakawa”), a legendary salesman at Nomura, established AIJ Investment Advisors Co. (“AIJ”) in 2000 and launched the AIM Global Fund (“Global Fund”), a Cayman-based hedge fund, in 2002. However, AIM Asset Management did not have a license to provide discretionary investment advice and Asakawa feared it might be a violation of a securities law to manage the newly launched fund. Asakawa learned that Cigna International Investment Advisors, a discretionary investment adviser and subsidiary of a large US-based insurance company, was considering closing the business in Japan. AIJ negotiated for Cigna to become the investment manager of Global Fund. Cigna agreed with the arrangement and eventually merged with AIJ in July 2004.
Asakawa was a visionary salesman. He clearly saw desperate demand for higher yield among smaller size institutional investors. Among all, corporate pension funds provided alluring opportunities as they were struggling to fill the gap between decreasing asset values and increasing liabilities. On average, Japan’s pension funds only generated 2.98% p.a. from 1996 to 2002, far short of the actuarial target of 5.5%. By 2010, most small and medium sized pension funds were significantly underfunded
Asakawa teamed up with Mr. Shinpei Matsuki (“Matsuki”), a long-time buddy and former head of Nomura’s powerful equity department, and marketed Global Fund as an absolute return strategy with very low volatility. Asakawa told his investors that Global Fund would generate attractive returns through various option strategies, including collecting premiums by selling put options on the TOPIX index. Asakawa’s smooth talk easily attracted many pension managers and money started flowing into the fund. As Global Fund continued performing well through the financial crisis, the firm’s AUM ballooned to over $2 billion (Exhibit 5.1 and 5.2).
Exhibit 5.1: AIM Global Fund track record since its inception
Source: Diamond Magazine, Bloomberg
Exhibit 5.2: AIM Global Fund AUM, Reported By AIJ (100 million Yen)
AIJ’s investment strategy could have generated the promised returns if Japan’s stock markets had either risen or stayed flat. Unfortunately, Mr. Markets weren’t kind to AIJ: TOPIX fell more than 30% for the first 9 months and over 60% from March 2006 to March 2009. As the strategy kept struggling, Asakawa, who feared massive redemptions, resolved to hide the losses from investors, hoping he can recoup in the future.
Through 2012, however, the Global Fund continued its losing streak and the total amount of losses from derivatives trading surpassed JPY 109 billion. The fund’s custodian could only confirm the existence of JPY 25 billion – in other words the fund had accumulated fictitious profits of JPY 293 billion (Exhibit 5.3).
Exhibit 5.3: Accumulation of Phony Profits
Source: SESC, the author’s calculation
Asakawa wove a complex web of structures to hide the losses from public. First, he created a BVI-based administrator called AIA. AIJ was a 100% owner of the company and Asakawa became a director. He also established ITM Securities Co., Ltd. (“ITM”), a Japanese brokerage firm, with Mr. Hideaki Nishimura, and allowed ITM to become a placement agent for AIJ’s Global Fund. AIJ controlled over 80% of ITM through two controlled companies.
Exhibit 5.4: AIJ’s Key Subsidiaries
Source: Created by the author using the SESC document
AIA was assigned be a fund administrator for Global Fund and reported NAVs to investors and trust banks through ITM Securities. According to the media source, the conflict of interest and suspect relationships between AIJ and AIA was never disclosed to investors as this scheme helped AIJ to hide its massive losses for over ten years. AIJ also set up two private funds in Japan, Venture Investment Alpha I and Venture Investment Alpha II. At the later stage of this scheme, Global Fund transferred the majority of new subscriptions to those two funds and used them to pay redemptions. The valuation policy of the subsequent funds is not disclosed, but it probably helped Global Fund and AIA to conceal the size of losses and helped to manage cash flow. Lastly, AIJ and Global Fund did not have maintain any prime brokerage relationships, as they probably wanted to avoid unnecessary attention toward their failing business.
In February 2012, AIJ’s operations were suspended by FSA. All redemption requests were upheld as the regulator continued investigation. On Mar 27, Asakawa appeared for the first time in public after the scandal when he was summoned by the House of Representative’s finance committee and admitted to perpetrating the fraud.
Exhibit 5.5: Valuation Scheme
Source: Created by the author using the SESC document
Confirm how an investment manager can execute trades without a prime brokerage relationship.
- It is important to understand how an investment manager executes complex trades efficiently and without interruption. Prime brokers usually provide the best trading services and executions for hedge fund managers.
- The fact that AIJ didn’t have any prime brokerage relationships is a concern. The firm disclosed the total trading volume of $713 billion (Exhibit 5.6). It is nearly impossible to execute this amount of transactions without legitimate and well-known prime brokerage services.
Exhibit 5.6: AIJ Trading Volume (2010)
Source: AIJ’s 2010 Annual Report
Investigate a history of an investment manager
- AIJ began its operation in 2002 as a non-discretionary investment advisor and was not allowed to manage a fund by itself. Without permission, AIJ launched a Cayman-based fund in 2002 and lent a name of Cigna, which had a discretionary advisory license, to serve as an investment advisor of the fund, until their merger in 2004. This is potentially a violation of the securities law in Japan. Investors could have pieced these facts together after reading its offering documents carefully or could have sought a legal opinion.
Check employees’ past record
- Matsuki’s criminal record shows that he was arrested in 1997, when he was Nomura’s head of equity division, and sentenced 8 years (with suspension of 3 years) for his involvement with an infamous payoff scandal. This was widely publicized incident and potential investors should have sought out the reasons why Asakawa decided to hire him.
Check an affiliation of a placement agent
- ITM Securities was Global Fund’s placement agent in Japan and directly owned by AIJ (80%).
- This fact by itself is a problem, but investors should also know that there is conflict of interest between the placement agent and the investors.
Check legitimacy of an administrator and its relationship with an investment manager
- Offshore administrators must be recognized by local authorities to provide administrative services to regulated mutual funds (including hedge funds). The list of licensed/regulated administrators is available online.
- AIA was established in the British Virgin Islands, but it is not recognized by the BVI Financial Services Commission as a “Sub Cat. B – Admin of Investments Mutual Funds”. See online search screen shot below (Exhibit 5.7).
Exhibit 5.7: Admin Search Result
Pension Fund Association, “Performance Update of Pension Funds”, http://www.pfa.or.jp/jigyo/tokei/shisanunyo/shisanunyo01.html (Japanese)
AIJ, “2010 Annual Report”, http://www.aim-ij.com/20120224-22rep.pdf (Japanese)
SESC, “Supplemental Information” for AIJ, March 23, 2012, http://www.fsa.go.jp/sesc/news/c_2012/2012/20120323/01.pdf (Japanese), http://www.fsa.go.jp/sesc/english/news/reco/20120705/01.pdf (English)