EM Investment Funds
Many UK investors pulled money out of EM (emerging market) funds in the recent crisis, but by 2010 the market was growing again. By summer 2012 the number of EM hedge funds had reached an all-time high with 1,073 funds (14 per cent of all hedge funds globally).
EM (emerging market) investment funds began to emerge in the mid-1980s when the International Finance Corporation (IFC) set up the first mutual fund that invested solely in securities from EMs, with seed capital of around US$50 million. Since then the EM fund community has grown exponentially, with hedge funds experiencing some of the fastest inflows of money.
According to Hedge Fund Research, in 2012 EM funds had approximately US$121 billion in assets under management. Investors have stampeded into EM equity-driven hedge funds largely because of impressive returns. Before the global financial crisis in 2008, many EM hedge funds were delivering returns in excess of 25 per cent annually, well above the hedge-fund industry average in the developed world.
This recent inflow of money is perhaps powered by the realisation that Asian economies may be in the process of slowing down and investors want to make money from local equities falling in value.
EM returns may be hit by deterioration in the sovereign debt crisis among developed countries (their main customers), a rise in inflation, bad loans, corruption and strengthening currencies. If the cynics are right, investors need a hedge-fund manager to play both short and long the local markets.
An example EM hedge fund
One of the most successful recent EM-based hedge funds is GAM Talentum Emerging Long/Short fund, managed by Enrico Camera and Iain Cartmill. This US$70.1 million fund invests largely in shares, with one-, three- and five-year annualised returns of about 9 per cent (based on 2012 returns).
Importantly, these solid numbers don’t seem to have come about from excessive risk-taking, with the fund’s worst drawdown or peak-to-trough fall at less than 7 per cent versus a sector average of more than 40 per cent. In fact, in 2008 the fund gained 8.7 per cent while the MSCI Emerging Market Index lost more than half its value.
The fund’s managers say that the secret is to focus on mining information about up-and-coming earnings revisions, echoing many developed-world peers who closely monitor earnings estimates to find companies that may pull a positive surprise.
The managers go long on companies deemed to have a competitive edge and whose valuations and prospects they believe have been underestimated.
A Financial Times report in spring 2011 noted that the fund’s managers ‘believed analysts weren’t appreciating the upside that AVI, a South African consumer staples and healthcare products retailer, was likely to experience as a result of the company’s new plant investments coupled with the country’s rising disposable income. Within a year, the stock had doubled. On the short side, the fund bets against companies that are likely to be hit by competitive and macro headwinds.’
Remembering the risks of an EM-focused strategy
EM hedge funds may be popular, but they still represent only 5 per cent of the hedge-fund universe, with a tiny handful of EM funds boasting more than US$1 billion in assets.
Crucially, many investors still insist that the EM opportunity is based on beta (the measure of a security’s volatility or systemic risk); that is, in reality you’re not really taking a noncommittal bet on EMs but betting that these local equity markets are going to carry on increasing in value.