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REUTERS - A mood of fear and nervousness hung over Japan's hedge fund industry on Monday as regulators widened an investigation into the suspected disappearance of more than $2 billion in corporate pension funds managed by Tokyo-based AIJ Investment Advisors Co.
Hedge fund industry sources said they feared the scandal could drive Japan's pension funds away from hedge fund investments, dealing a blow especially to independent and small-scale funds that look after less than 5 percent of the nation's around $800 billion in company pensions.
On Friday, Japan's financial regulator shut down AIJ for a month amid suspicion it may have hidden losses in the $2.6 billion pension funds it managed.
"This is definitely negative for the industry. We fear pension funds would withdraw from alternatives, including hedge funds, especially from small and mid-sized hedge funds like us," said an executive at one Japanese hedge fund, who asked not to be identified due to the sensitivity of the issue.
Japan's Financial Services Agency (FSA) is investigating more than 260 other discretionary asset managers to check for similar problems.
And the Securities and Exchange Surveillance Commission (SESC), the country's securities watchdog, is looking into ITM Securities Co, a small Tokyo-based broker, over its possible role in the AIJ scandal, two sources with knowledge of the matter said on Monday.
ITM uses the same central Tokyo office building as AIJ and acted as its agent in selling AIJ funds, the sources said on condition of anonymity as the investigation is not public.
Japanese corporate pension funds have 60-70 trillion yen of assets under management, with nearly 5 percent allocated to hedge funds, according to the Pension Fund Association.
Corporate pension funds only really started to put money into hedge funds in 2005, looking to improve on an annual return of 3-5 percent due to ultra-low interest rates in Japan and a prolonged slump in domestic share prices.
AIJ had told prospective clients it delivered cumulative returns of up to 240 percent, according to local media.
The Government Pension Investment Fund (GPIF), Japan's public pension fund and the world's largest, logged its worst investment performance in three years in July-September, losing $48 billion, with a rate of return of minus 3.32 percent.
"It will be difficult for smaller pension funds to invest in hedge funds again. It's really sad that a bad asset manager can ruin the overall industry, even those doing their job properly," said Kazutaka Oshima, president of Rakuten Investment Management.
Japan-focused hedge funds managed about $16 billion at end-February, up from $15.6 billion a year earlier, according to industry tracker Eurekahedge, but less than half the peak of $39 billion in April 2006 before the global financial crisis triggered in part by the collapse of Lehman Brothers.
Hedge fund industry sources said they had heard rumours about AIJ several years ago.
"As an industry rival, we've tried to find out what AIJ was doing because of the size of its assets and its high returns," said a senior fund manager at a Tokyo-based hedge fund company, who also didn't want to be named. "We usually hear something about it, but in AIJ's case we couldn't find out anything."
Another hedge fund executive said he first heard concerns about AIJ in early 2009 after the Madoff scandal broke. Japan has not seen a fraud case on the scale of convicted fraudster Bernard Madoff's Ponzi scheme, but it has had its fair share of investment scams.
Citing documents he received from within the industry, the executive said AIJ was a quantitative fund with a 4-year track record that showed only two months of negative returns.
"It was too good to be true. No matter how good they are, it's just impossible," said Tokyo-based Manabu Washio, CEO of Aksia Asia, an independent hedge fund research and advisory firm headquartered in New York
"Most of the pension funds who invested in AIJ were from the lower end of the knowledge spectrum ... (those) who rely on track record or word of mouth."
Several hedge fund managers said they were busy handling queries from nervous clients.
"We've received calls from some of our clients asking whether our fund was okay. They're very nervous," said a fund manager at another hedge fund company.
"We want the FSA to conduct a thorough investigation to check investment advisers. Otherwise, investors and pension funds won't be able to take away their unease towards the industry."
Reporting by Chikafumi Hodo in TOKYO and Nishant Kumar in HONG KONG; Editing by Ian Geoghegan