Six of the top 50 most consistently performing global hedge funds invest in volatile emerging markets. It’s a surprising finding from Global Investment Report’s 21st annual survey over the last five years through 2023.
The six funds posted average returns of more than 12.5 percent during that period, according to the report. Four of the six were credit funds.
Emerging markets were especially vulnerable when the Fed pushed up interest rates in 2022. BarclayHedge EM Global Equities Hedge Fund Index lost 17 percent in U.S. dollar terms that year, double the 8.2 percent loss of the average hedge fund across all strategies. But the six EM funds in the Top 50 survey rallied by more than 2 percent in 2022.
These funds’ consistency was also evident in the years before and after rates soared. In 2019, 2020, and 2021, the average return of the six funds was 14.2 percent, 14.9 percent, and 16 percent, respectively. Then in 2023 they rallied an average of 16.6 percent. And through the first half of 2024, EM was the top-performing strategy, up more than 9.5 percent.
(In a webinar on October 15, the author led a discussion with EM managers including Wellington Management, Cheyne Capital, and Sandglass Capital on how they generated consistent returns.
Funds sustained their returns by sidestepping drawdowns. This was accomplished in a number of ways, according to interviews with several of the managers.
Managers said one key driver in debt is the relatively small percent of dedicated funds versus total assets.
EM-dedicated credit hedge funds control about $10 billion out of $3 trillion of existing debt, said Waha EM Credit manager Mohamed El Jamel. Multistrategy funds may trade another $10 or $20 billion.
Accordingly, he sees “more alpha potential in EM credit than in developed markets, which enjoy higher levels of research, far more liquidity, tighter spreads, less dislocation, and lower volatility.”
The second driver is a tight focus on risk management. Because emerging markets are volatile, El Jamal imposes strict position and industry exposure limits and maintains significant diversification that’s informed by historical correlations.
This has kept consecutive monthly drawdowns to just two months. The $700 million fund that’s based in Abu Dhabi, and which is number 37 on the list, has had only one down calendar year in 2014 when Waha lost 40 basis points. Over the 12 years since its launch, according to BarclayHedge, the fund has generated dollar-based annualized returns of 9.7 percent, volatility of 4.5, and trailing 5-year market correlation of 0.23 through 2023. Through the first half of 2024, it’s up more than 10 percent.
Promeritum, a $400 million London-based EM credit fund, said steady performance can be attributed to on-the-ground research. The fund has not had a down year since its launch in January 2015.
Co-managers Pavel Mamai and Anton Zavyalov credited this in part to their extensive network of local personal relationships in each emerging market in which the fund invests. This support helps identify opportunities and risks.
Published data, he said, can only take one so far in discerning trends across local politics, foreign exchange policy, business support and taxation, regulation, and litigation. “Local contacts, explained Mamai, “can help decipher what’s motivating the actions of governments and state-owned companies and then match that against what actually transpires.”
The network also promotes better understanding of what’s driving IMF and World Bank decision-making, whose statements and actions can directly affect a fund’s performance.
The 44th-ranked fund generated average annual returns of 8.4 percent through 2023, with an annual standard deviation that was a smidge over 4, and correlation to the S&P 500 of 0.18 over the past five years. Promeritum is on pace to generate comparable returns this year.
Managers said another driver of consistent performance was a well-honed macro sense. Commodity prices, interest rates, and global shipping prices and availability are significant drivers of the economic health of emerging markets—which are determined by factors well beyond their borders. During the pandemic when ports were backed-up, for example, emerging markets suffered when their products couldn’t reach the U.S.
Geopolitical conflicts, also out of their control, take a big toll on these markets. Russia’s invasion of Ukraine triggered food shortages across Africa. The wars in the Middle East increased global oil prices and added uncertainty to elections around the world.
War has a tragic human toll and puts investor capital at risk. Most PMs who owned Russian assets wrote down the entire value of their investments not long after the invasion of Ukraine began in 2022.
The rapid normalization of macro and economic policy and improving relationships with external creditors across a range of distressed sovereigns and corporate issues are driving credit opportunities across much of the market right now, explained Genna Lozovsky co-founder and CIO of Sandglass Capital.
The 33rd-ranked Sandglass, which is based in London, is a special situations fund that focuses on credit. The fund is up 24 percent through the first two-thirds of 2024. That’s triple the $400 million fund’s annualized returns since its inception more than a decade ago. Maintaining a bit of equity exposure, Sandglass’ volatility runs higher than some other EM credit funds (10.7) as does its market correlation, which stood at 0.57 at the end of 2023.
Asset managers and banks have a positive outlook for the space. J.P. Morgan wrote in August that “earnings growth for EM in 2024 and 2025 is nearly 17 percent and 15 percent respectively, compared to less than 11 percent and 14 percent in the United States.” The bank said valuation spreads between developed markets and EM are more than 30 percent compared to a historical average of 24 percent.
Lazard Asset Management believes this gap, “may narrow” because of stronger earnings growth and other attractive metrics in emerging markets. But it cautions that despite China’s new robust economic policy announcement, the country’s slowing growth could still weigh on these markets.
Given Sandglass’ outperformance this year, Lozovsky has been harvesting profits and reinvesting in new opportunities, which he said may not appreciate as rapidly as some previous positions.
“We’re seeing improving macro conditions across a range of emerging and frontier markets as interest rates continue to fall which is supporting growth,” says Lozovsky, “Accordingly, increased investor sentiment has reduced the spreads in distressed opportunities.” And while he believes the investment impact of two major wars have so far been manageable, he acknowledges that can change.
