Hedge Funds in Emerging Markets

---

Databases by asset class

Broadly speaking, domestic hedge funds feature higher assets under management and higher hurdle rates than their EM counterparts, while also maintaining lower management fees, incentive fees, and water marks Table 2. We would expect the opposite, as foreign securities are typically more illiquid. EM hedge funds also experience half the monthly net inflows of non-EM hedge funds 0.

We run a generalized additive model GAM to evaluate the statistical significance of the emerging markets variable. As shown in Output 1 , EM hedge funds earn a statistically significant positive excess return over non-EM hedge funds, after controlling for fund size, strategy, assets, and hurdle rates. EM monthly returns on investment are typically 0. However, EM monthly return volatility is also 0. Unlike prior research, we dive into the granularities of various EM hedge fund strategies. In terms of overarching buckets, Event-Driven, Equity Hedge, and Macro funds are particularly successful in emerging markets Output 2, Figure 4.

Theory supports the data.

Which Emerging-Market Hedge Funds Perform Best?

On average, EM event-driven funds outperform domestic counterparts by 3. Macro hedge funds, meanwhile, apply proprietary screens and top-down analysis across a greater array of investment options. Diversification across countries allows algorithms to cherry-pick securities with clear mispricing and a wide margin of safety. A final noteworthy result is the statistically significant outperformance of emerging market Fund of Fund hedge funds.

JEL classification

Fund of Fund performance stems from skill in picking managers and not in picking securities, and appears to also benefit from a larger opportunity set of funds. The figure below illustrates the significant differences in return profiles for particular implementations of Equity Hedge, Event Driven, and Macro approaches. Overall, nine out of the initial 34 hedge fund sub-strategies generate consistently superior results when obtaining exposure to emerging markets.

Styles such as Fixed Income, Special Situations, Quantitative Directional, and Commodity Multi-Strat all point to the ability of emerging market managers to exploit lower transparency and higher return variance in EM securities. EM hedge funds specializing in energies often add a regional focus in countries crucial for understanding commodity supply and demand Saudi Arabia, Qatar, and other Middle-Eastern areas. These results support the findings of Kotkatvuori-Ornberg , which stress the importance of local informational advantages in raising performance.

To satisfy the minimum investment requirements for the largest funds in each EM strategy, we pool capital across many investors in a fund-of-funds structure. Back-tested results of the blended portfolio are compared to a purely domestic portfolio in Output 4.

Latest Analysis

As shown, the EM Portfolio registers a 0. Emerging markets are generally less efficient than developed, ergo there should be lots of opportunities for hedge funds to prosper in emerging markets.

That argument is compelling, but perhaps what is surprising is that, while a growing number of hedge funds are targeting emerging markets, there are not more. India is a good case. The market structure is very evolved but there is still alpha to be gained on both sides. Moniz argues that the Indian equity market has a dichotomy between two extremes.

As a result, while one set of companies is growing rapidly, another set, often capital-intensive such as manufacturing and real estate, is impaired, he argues.

The net result is a wide dispersion in both the underlying business performance of companies and their stock prices. In contrast to the US and Europe, this also means that hedge funds do not need access to prime brokers to short stocks and can do so via an exchange. The drawback to this, says Alper Ince, managing director at the hedge fund of funds provider PAAMCO, is that liquidity tends to reside only in the nearest contract, and investors are taking roll risk at various interest rates, depending on the environment, as they switch from expiring contracts to the next shortest maturity.

In contrast, Hong Kong, China and Singapore are markets where hedge funds are firmly ensconced. These markets have evolved to the position where there are now second-generation spin-offs from older firms as well as established hedge funds. Arbitraging among mainland-listed stocks, Hong Kong-listed and American Depositary Receipts creates lots of opportunities, adds Patrick Ghali, managing partner of London-based Sussex Partners.

But one telling comparison is that the ratio of hedge fund investments to total market capitalisation is 4. India is even lower at 0. Ince sees Brazil as an emerging market with a significant hedge fund industry. However, it has been a difficult place to generate value until recently because it has been a top-down-driven market suffering a recession and political uncertainty.

Running net short positions, says Ince, is difficult, with significant risks as asset flows are shifting towards emerging markets. Ince argues that Brazil will be interesting in the future, particularly if the political environment stabilises and the current government passes planned fiscal reforms. He believes Mexico is another interesting market, with significant liquidity and an environment significantly tied to a US recovery, given its trade links through the North American Free Trade Agreement.

Some of the smaller emerging markets are also interesting as they grow their GDP and have more IPOs coming to the markets. For Ince, these include South Africa, Turkey and possibly even Russia, which has a small hedge fund community that tends to favour net long-directional strategies. This market could become interesting if the political environment ever stabilises. There are also some global-macro funds that have a focus on emerging markets and there is even the occasional global fund domiciled in an emerging market. However, debt markets are likely to grow in importance as these increase in size and liquidity.

London-based Whard Stewart trades local currency, emerging market yield curves and exchange rates. We trade local currency yield curves just as in the US, UK and so on.

By assessing the shape of a given curve, the firm identifies apparent mispricing along it. This enables it to put on trades, usually forward starting swaps and options. Its strategies are dependent on analysis of policy, and the past four years have been difficult due to the extraordinary monetary policies conducted by central banks.

Historically, as Beukes says, emerging markets have been difficult for hedge fund strategies. The markets have often not been liquid enough, there has not been enough capacity to enable funds to grow, and there has been an inability to hedge out specific risks.

However, as the markets develop, the opportunities to generate alpha seem more attractive than they are in already developed economies. The issue may be whether end investors can generate alpha at attractive fees. Surveying the surveys Sat, 1 Sep

• The Secret Adversary (Tommy & Tuppence) (Tommy and Tuppence Series Book 1)
• The Cresperian Alliance
• Wie ein Prinz aus dem Märchen (ROMANA) (German Edition)
• RF and Baseband Techniques for Software Defined Radio (Artech House Mobile Communications)
• Sunshine State
• The War Cloud
• Sankt-Rochus-Fest zu Bingen (German Edition)